A Dynamic Model of Collusion

A monitor is hired to control the agent. Despite the lack of side-contracting opportunities it is shown that the agent and the monitor can collude. The conditions for such implicit collusion are that the monitor should expect future rents from a continued relationship and the agent should have the authority to influence these rents and a credible threat to do so. The paper shows that the credibility of the agent's threat depends on how the principal will interpret a disagreement between the agent and the monitor, which in turn depends on whether the principal expects collusion to take place. The dynamic model of collusion we offer fits the accounts of lawyers, sociologists and auditors on the nature of collusion and it enables us to ask and answer some new questions. First, the extent of collusion will depend on the monopoly power (rents) of the monitors. Second, in contrast to a static model with explicit side-contracts, using the threat of lawsuits combined with a flat fee for the monitor rather than bonuses may be the optimal method of controlling the monitor. Third, the behaviour of the current monitor will depend on the expected behaviour of other monitors and thus a multiplicity of equilibria is possible. Fourth, the number of tasks that the monitor has may influence the possibility of collusion. Finally, our model can be used to jointly determine the allocation of authority and the reliability of information flows within the organization.