Race to collusion: Monitoring and incentive contracts for loan officers under multiple-bank lending

The possibility of vertical collusion between an informationally opaque borrower and corruptible loan officers, to whom the task of monitoring is delegated, in bank-loan officer-borrower hierarchies shapes the incentive contracts for the loan officers. Collusive threats exacerbate incentives for overmonitoring, and make monitoring efforts of the banks strategic complements because of a novel ‘race-to-collusion’ effect—a hitherto unexplored effect of multiple-bank lending. Thus, delegation contract solves the free-riding problem in the presence of monitoring duplication, and may lead to higher levels of per-bank monitoring in multiple-bank lending. Moreover, over-monitoring, albeit inefficient relative to the optimal contract in the absence of race-to-collusion, may enhance social welfare. We further show that the collusion-proofness principle may fail to hold under multiple-bank lending.