Collusion in Hidden Action Models

We analyze implications of collusion in a oneshot moral hazard model in which agents perfectly observe others’ choices and are allowed to write binding side contracts. In this setting, we demonstrate an example in which the unique incentive compatible and individually rational optimal contract is not immune to collusion. Collusion constraints, restricting the principal to consider contracts that are free of collusion, are identified: A contract is collusionproof if there is no other feasible side contract that makes some of the agents strictly better o , while not hurting the others. Our main result is to prove the existence of an optimal collusionproof contract under the very same assumptions needed for the existence of an optimal incentive compatible and individual rational contract. The basic distinction between our approach and others’ is the use of cooperative game theoretic tools in the analysis of the interaction among agents. Consequently, our model is not susceptible to the well known problem of multiplicity of equilibria in the play among agents.