Collusion and Renegotiation in a Principal-Supervisor-Agent Relationship

Abstract

This paper describes a principal-agent relationship with a supervisor who has information about the agent. The agent and the supervisor have the possibility to collude and misinform the principal. From the literature we know that there exists an optimal contract which excludes collusion in equilibrium. The optimal contract, however, is ex post inefficient and creates scope for renegotiation. If renegotiation is allowed then under some parameter constellations the optimal contract is a contract which necessarily induces collusion. The paper thus shows that the principal's behavior toward ex post inefficiencies may determine whether collusion occurs in equilibrium.