Resource allocation within a budgeting game: truthful reporting as the dominant strategy under collusion

Both the Groves scheme and profit-sharing can lead to truthful reports produced by the better informed divisional manager for the benefit of the less well informed headquarters in charge of intra-firm resource allocation. However, both schemes have certain shortcomings: while the Groves scheme is susceptible to collusion among divisional managers, profit-sharing does not strictly ensure that truthful reporting is the dominant strategy in the case of each divisional manager. Both shortcomings can be remedied by combining the Groves scheme with an additional penalty scheme related to the Weitzman scheme. Using a game-theoretic approach, this paper introduces a new success indicator that establishes truthful reporting as the dominant strategy and prevents collusion or contractual agreements among divisional managers. In sum, this paper’s theoretical results predict that applying the new success indicator leads to a higher level of truthful reporting, and therefore to more efficient resource allocation, than applying either the Groves scheme or profit-sharing alone. Copyright Springer-Verlag Berlin Heidelberg 2014