Implicit Collusion in Hierarchical Relationships

We reconsider Tirole's framework of a three-tier principal-agent problem, in which he has shown that an incentive problem is caused by the possibility of monetary side payments between the agent and the middle -level supervisor. We consider the case where monetary transfers are not possible, but a different, implicit kind of collusion arises because the supervisor cares about the utility enjoyed by his subordinate. This approach avoids the crucial problem of how an explicit side contract could be enforced. We show that the difference in the cause of collusion leads to a difference in the way in which collusion is prevented: the agent's incentive scheme is used to give incentives to the supervisor. An interdependence between incentive schemes thus follows from utility interdependence.