Counter Marginalization of Information Rents: Implementing Negatively Correlated Compensation Schemes for Colluding Parties

A principal contracts with a productive agent whose production cost is private information and with an insurer who can insure the principal against variations in the payment to the agent. The insurer and the agent can collude in their responses to the principal's contract. Non-cooperative play of the principal's contract constitutes the outside option for the colluding parties. In this setup, we characterize the implementable outcomes for the principal. We then identify the optimal implementable outcome under the assumption that the principal faces a budget constraint. The optimal outcome provides the principal with "partial" insurance. For higher realizations of the production cost, the budget may not be exhausted even though the principal is not directly concerned with the unspent portion of the monetary funds.