On monitoring and collusion in hierarchies

This paper studies a stylized three-layer agency framework in which a princ ipal hires a supervisor to monitor an agent's productive effort. It is demo nstrated that the possibility of collusion imposes no additional cost on th e principal if the supervisor's report is "hard" information, i.e., monitor ing evidence call only be concealed and not forged. This result holds irres pective of the nature of the penalty that can be imposed on the agent. The findings suggest that it is strictly better for the principal to monitor th e agent's action rather than to audit the agent's private information. Jour nal of Economic Literature Classification Numbers: D82, L23. (C) 2000 Acade mic Press.