Collusion and Delegation in Organisations, Term Paper Example

Supervisors and agents can communicate in hierarchical organizations to keep knowledge from the principle out of their hands. This aspect implies collusion; it is defined as forming a strategic alliance between members of a group at the cost of other members of the group. Collusion is a significant challenge in the principle-agent relationship. When a principal wants to monitor one of their employees, they may enlist the aid of a supervisor. As a result, the supervisor is ultimately responsible for the agent’s performance. Delegation is a factor in this challenging scenario because the principal delegates the monitoring role to the supervisor. As a result, the supervisor may be more susceptible to the agent’s offer of compensation in exchange for fabricating his observation. Thus, an information asymmetry arises between the principal and the agent because the supervisor does not provide accurate information. The principal-agent relationship suffers from poor decision-making due to this information mismatch. Laffont & Martimort (1997) and Laffont & Martimort (1998) evaluate these concepts in their research.

Critical Review

Laffont and Martimort (1998) explain that when comparing hierarchical versus decentralized organizations, the agency costs associated with the multiple side-contracting games that agents participate in must be considered. The goal of organizational design is to establish routes for information flow and to share authority correctly. The researchers concluded that according to their organizational structure, agents are compensated asymmetrically and given varying degrees of power and responsibility (Laffont & Martimort, 1998). On the other hand, decentralization implies delegating all decision-making to a centralized group of agents. Collusion is not a worry in a centralized organization, according to (Laffont and Martimort, 1998), since communication between agents and the principle is unlimited. Therefore, in this case, centralization will always triumph over delegation. However, collusion is still possible under centralized control because of communication restrictions such as incomplete contracts (Laffont & Martimort, 1998).

The concept of incentives lends credence to this notion. According to the incentive theory of motivation, human behavior is motivated by a desire for reinforcement and incentives. Therefore, individuals behave in ways in which they anticipate being rewarded while avoiding activities that they fear will result in punishment. In organizations, this aspect presents through Employees who are driven by many factors to work hard and be loyal to their employers. For many employees, incentives for exhibiting a good work ethic are a significant source of motivation. This factor means that employees’ reactions to a certain incident might vary based on their incentives. For instance, supervisors might be more loyal to their principals if they anticipate greater rewards for their good work ethic. Nonetheless, individuals may place a different value on rewards. For instance, a principal’s reward system might not incentivize their agent when the latter does not value the proposed incentives. Psychological and cultural variables may also impact people’s motivation for different incentives. Therefore, incentives must be seen as an encouragement to be successful. Coalitions may be defined via the application of incentive concepts.

Despite its importance in explaining the formation of coalitions or the collusion between supervisors and agents, the theory of incentives struggles when confronted with the perplexing problems of information asymmetry and communication costs (Laffont and Martimort, 1998). Therefore, this study proposes the revelation principle as a mediating factor in this case. As described by Laffont and Martimort (1998), the revelation principle explains how a decentralized resource allocation system may be implemented in a centralized framework just as well. Depending on the information they supply, individual agents may communicate directly with a mediator or a principle in exchange for action plans. This factor demonstrates that an organization does not need hierarchical communication channels if everyone acts in their self-interest and the leader communicates effectively with everyone. Additionally, each bilateral contract that links the agents influences the centralized grand contract. This argument, however, is intensively reliant on the concept of communication revelation in game theory (Laffont and Martimort, 1998).

According to the economics revelation principle, truth-telling or direct revelation mechanisms may be created in most cases to reach the Bayesian Nash equilibrium result of other mechanisms. This factor is apparent in many mechanism design scenarios. In other words, the revelation principle states that each Bayesian game has a payoff-equivalent disclosure mechanism that assures players to reveal their approaches when they are in equilibrium. However, in a Bayesian game, the players’ characteristics are unknown, sometimes referred to as their payoffs. As a consequence of this information asymmetry, at least one player in a Bayesian game is uncertain about the type of the other player or players. In general, it is possible to demonstrate the presence and comparability of a direct revelation process (in which speaking the truth is a Nash equilibrium outcome) (Laffont and Martimort, 1998). In this context, a direct disclosure strategy is one in which the techniques are identical to the information that a player may disclose about himself.

Despite the principle-agent tenets of the disclosure principle, collaboration and delegation undercut the concept’s foundation (Laffont & Martimort, 1997). According to Laffont and Martimort (1997), the Revelation Principle is predicated on several implausible assumptions when applied to businesses. First, it assumes an unrestricted exchange of information between parties. It also forecasts the actors’ Bayesian-Nash behavior as a second assumption. If agents breach their contractual obligations, they become null and invalid, and the principal has the authority to terminate them. As a consequence of this assumption, internal communication tends to be costly. Laffont and Martimort (1997) explain that many scholars have indicated that the principle has complete discretion over whether or not to approve this interaction. Because the Revelation Principle presupposes a lack of collaboration inside the organization, it consistently underestimates the influence of informational limitations on the allocation mechanism selection process. Allowing for collusion should be the norm rather than the exception in a more realistic view of incentive theory (Laffont and Martimort, 1997). However, this study focuses on information asymmetry in coalitions.

Coalitions have been proven to invalidate conclusions obtained when just individual incentives are evaluated in the literature (Laffont and Martimort, 1997). This study elucidates that Groves’ first-best-choice approaches are not immune to coalition-building when full information is accessible. While all social choice functions can be realized in strong Nash equilibrium, only a small number can be realized in Nash equilibrium alone. Therefore, the research finds a significant conflict between the individual and coalition incentives when a differentiated method is adopted, and a dominating strategy is needed (Laffont and Martimort, 1997). Only decision rules that need complete pooling may be generated using two-differentiable techniques. The number of contract types grows as the number of coalition incentive conditions that must be met by a collusion-proof contract grows. Consequently, non-complete pooling decision rules may be used if implemented in Bayesian-Nash equilibrium, and the coalition members who contribute knowledge agree to stay in it.

According to Laffont and Martimort (1998), communication costs vary depending on the firm’s organizational structure. A critical consideration in the organizational structure is that the principle has complete control over communication flows in a centralized organization. In contrast, agents have total authority over communication flows in a decentralized organization (Laffont and Martimort, 1998). This consideration implies that one can completely remove all bilateral contact between agents without any communication costs. Consequently, no agreement between organization members can be enforced on top of the principle’s grand contract; their conduct is hostile. The inability of agents to coordinate their signals in the grand contract supports their Bayesian-Nash behavior when reporting information. As a result of this stumbling block, the second assumption of zero communication costs with the principle is called into doubt. Because both the primary and agents have the power to interact freely, this is a core premise of the revelation principle. Similar assumptions about how an organization communicates are required to draw comparisons across organizational systems.

As a result, the communication cost between agents, supervisors, and the principal significantly affects how they interact. Agents aim to coordinate and influence their reports into the principal’s mechanism when contact is possible and cost-effective. This issue also affects the coalitions that these parties establish. These alternative models demonstrate that information signaling and bargaining present significant issues When information is asymmetric (Laffont & Martimort, 1997). They all suggest that the game of coalition-building may produce a variety of outcomes in response to a single principal’s offer. This diversity would enable us to develop a more nuanced picture of how history and other external factors affect the degree of collaboration in a corporation. However, multiplicity is less desirable when assessing the influence of these collusions in the entire organization (Laffont and Martimort, 1997).

These two studies suggest that collusion occurs when information is symmetrical and transmission costs are minimal. As soon as it is practical and cost-effective, agents engage with and influence one another’s reporting to the principal’s mechanism. These parties can also play a collusion game whenever they like. Furthermore, the agents’ agreement may adopt an interim shape after or before the grand mechanism is granted. First, one assumes that the agents have previously agreed to divide any asymmetric monetary payments received from the principle equally (Laffont and Martimort, 1997). These agreements are signed before the principal or agents have any say in their contract or access to the principal’s information. The principal will be required to issue anonymous contracts in the future due to this ruling, which is significant. Second, in response to the principal’s grand contract offer, a third party proposes a side contract (Laffont and Martimort, 1997).

Additionally, this scenario has many contract restrictions prohibiting agents and supervisors from collaborating (Laffont et Martimort, 1997). According to the Collusion-Proofness Principle by Laffont and Martimort (1997), studying massive processes that stay unaltered throughout coalition formation does not limit generality. As a result, the continuation game agents do not transfer money or alter their reports to the grand mechanism in an equilibrium condition. Laffont and Martimort (1997) indicate that a perfect Bayesian equilibrium for coalition formation arises when a third party proposes and the agent accepts a null side contract. The same logic applies in asymmetrical information circumstances as it does in symmetrical information situations. Consequently, a contract must be in place compatible with individual aims and aid in group cohesion (Laffont and Martimort, 1997). Additionally, this balance is maintained by fear of altering the grand contract via passive beliefs.

However, this is a problematic notion. In the game of coalition-building facilitated by passive beliefs, continuation equilibriums requiring a third party to offer a non-null side contract may be maintained. When a nondeviant agent’s faith in the grand mechanism is shattered by an out-of-equilibrium rejection of the side contract, a balance is established in which both types of agents accept the non-null side contract. Massive systems capable of surviving any possible equilibrium in the continuation game, even if it is entirely Bayesian, would be a superior option.

Conclusion

This critical review has evaluated the studies by Laffont and Martimort (1997) and Laffont and Martimort (1998) that analyze the concepts and principles of collusion and delegation in organizations. These principles are common and significant in principle-agent approaches and game theory. According to this study, information asymmetry and communication costs are the primary factors that affect collusion among principals’ supervisors and agents. Furthermore, these articles have relied on several theoretical foundations, including the theory of incentives and the revelation principle in game theory. Finally, the studies have also indicated how these factors play in the Bayesian-Nash game equilibrium to information collusion. Thus, this critical evaluation concludes that these studies objectively explain the intricacies of collusion and delegation in organizations.

References

Laffont, J., & Martimort, D. (1997). Collusion Under Asymmetric Information. Econometrica, 65(4), 875-911. https://www.jstor.org/stable/2171943.

Laffont, J., & Martimort, D. (1998). Collusion and Delegation. The RAND Journal Of Economics, 29(2), 280-305. https://www.jstor.org/stable/2555889.