Managers and their Discretionary Power ∗ Very Preliminary

We investigate optimal managerial contracts in a principal-manager-employee hierarchy with a moral hazard problem at the bottom. We allow for collusion and extortion. Side contracting between manager and employee takes place before the employee has taken his action. Information is soft under collusion. If the manager's sole duty is to report information and if we focus on collusion plus extortion proof grand contracts, we nd that there is a tension between preventing capture and collusion. This tension is such that it is in fact strictly optimal to give up on preventing capture. We then characterize the optimal contract which entails (i) partial delegation of authority to the manager and (ii) failure to elicit her information. It is optimal to partially delegate authority to the manager as it cancels the scope for extortion. JEL Classi cation: D82, D86, L23