While the literature on contracts under private information focuses on cost structures without fixed costs, we examine optimal contracts involving the possibility of collusion between the supervisor and the agent in the model in which the regulated firm's cost is composed of not only a variable cost but also a fixed one, both of which depend on private information.
We show that when a difference in the amount of fixed costs with respect to the agent types is sufficiently large, countervailing incentives may arise. We characterize optimal collusion-proof contracts under the condition that the supervisor can collude with the agent and that countervailing incentives will prevail because the set of binding incentive compatibility constraints and participation constraints depends on the value of the difference. Thus, it is of critical importance to consider type-dependent participation constraints when examining optimal contracts and collusion under asymmetric information. We also characterize optimal collusion-proof contracts to show that the less efficient types obtain positive informational rents.
To examine how competition affects the degree of corruption, we consider competitive sectors in which substitutes or complementary products are supplied. We show that in the regime with corruption, greater competition can enhance corruption. To explore the relationship between corruption and competition further, we also examine the case in which a better supervising technology can be considered as greater competition.
JEL Classification: D86, L22, L51.