On monitoring and collusion in hierarchies

This paper studies a stylized three-layer agency framework in which a principal hires a supervisor to monitor an agent's productive effort. It is demonstrated that the possibility of collusion imposes no additional cost on the principal if the supervisor's report is "hard" information, i.e., monitoring evidence call only be concealed and not forged. This result holds irrespective 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 the agent's action rather than to audit the agent's private information. Journal of Economic Literature Classification Numbers: D82, L23. (C) 2000 Academic Press.