"Renegotiation and Collusion in Organizations"

Leonardo Felli
(London School of Economics)

J. Miguel Villas-Boas
(University of California at Berkeley)

ABSTRACT

It has been argued that collusion among the members of an organization or a
vertical structure creates efficiency losses, and hence should to be prevented. 
This paper shows that whenever collusion takes the form of co-insurance 
agreements, here called `friendships', among the members of a vertical 
structure this may not be the case. Indeed, in such a case, collusion yields 
only a redistribution of surplus among the members of the vertical structure.  
Hence, its efficiency costs may be reduced by allowing these `friendships' to 
take place and accounting for the redistribution in the design of the optimal 
incentive scheme. These friendships are then a way to decentralize the 
implementation of the optimal incentive mechanism.