When to fire bad managers: the role of collusion between management and board of directors

We develop a model in which a shareholder hires a director to monitor a man ager who faces stochastic firing costs. We study the optimal incentive sche me for the director, allowing for the possibility that the manager bribes t he director in order to change his firing intentions. Such collusion may be in the interest of the shareholder, because it avoids the need to (ex ante ) compensate the manager for very high realisations of his firing costs (th ese are precisely the cases in which collusion occurs). (C) 2000 Elsevier S cience B.V. All rights reserved.