Collusion and discrimination in organizations

In a principal–multi-agent setting we investigate how optimal contracts should be modified under relative performance evaluation when agents collude. Agents may write side-contracts, which are not contingent on their effort choices but indirectly control them through sidetransfers. We show that the optimal collusion-proof contract is to introduce a ‘‘discriminatory policy’’ in the sense that the wage schemes offered to agents depend on their identities even if they are identical with respect to productive abilities. Such discriminatory wage schemes explain the organizational strategy of ‘‘divide and conquer’’ as an optimal response to collusion. r 2003 Elsevier Inc. All rights reserved. JEL classification: D20; J30; J70