Collusion Deterrence Mechanisms in Hierarchical Regulatory Contracts

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This paper studies regulatory contracts in a three-tier hierarchical structure of a principal, a monopoly firm which has private information, and a supervisor who is employed by the principal to bridge the informational gap between the principal and the firm. If the supervisor is self-interested, then collusion between the firm and the supervisor is possible. This paper derives a collusion-deterrence mechanism which attains the same welfare result as the collusion-free contract, even when collusion is possible. The timing of the supervisor's audit of the firm is found to play a crucial role in this mechanism.

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