Corruption with Competition Among Hidden Principals
Generally when there is increased competition on one side of the market, the other side is better off. We study the effects of increased competition among sellers when there is a potentially corrupt agent who procures the good on behalf of a buyer. The model consists of a principal (the owner of a ¯rm), an agent (the manager), and many \hidden principals" (suppliers of an input). Corruption occurs when an agent conspires with one of these hidden principals to appropriate gains at the principal's expense. Suppliers have two key attributes: production cost and \dishonesty" cost (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 ine±ciency. First, no transaction may occur, although it is socially e±cient to transact. 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 ¯nd that increased competition among sellers may in fact harm the buyer.
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