Corruption with competition among hidden principals

FEDERICO WEINSCHELBAUM

Mendoza

Conferencia; XXXIII Reunión Anual de la Asociación Argentina de Economía Política; 1998

Asociación Argentina de Economía Política

Generally when there is increased competition on one side of the market, theother side is better off. In this paper we study the effects of increased competitionamong sellers when there is a potentially corrupt agent who procures the good onbehalf of a buyer. The model consists of a principal (the owner of a firm), an agent(the manager), and many “hidden principals”( suppliers of an input). Corruptionoccurs when an agent conspires with one of these hidden principals to appropriategains at the principal’s expense.Suppliers have two key attributes: production cost and “dishonesty”co st (a utility penalty incurred from being corrupt). The effects of increased competition among suppliers depend crucially on whether new suppliers are heterogeneous across these characteristics. When the new suppliers vary according to their productivity levels and/or their honesty levels, there are three possible sources of inefficiency. First, no transaction may occur, although it is socially efficient totransact. Second, the most productive supplier may not be used because he is too honest. Third, the most productive supplier may not be used because the principal has (optimally) restricted the pool of potential suppliers. Importantly, we find that increased competition among sellers may in fact harm the buyer.