Optimal Debt Contracts when Credit Managers are (Perhaps) Corruptible

The paper derives the optimal organizational response of a bank (the principal) which faces a risk of collusion between the credit manager (the agent) and the credit-seeking firms. The bank can deter collusion either through internal incentives or by distorting the credit contracts. The model thus explicitly takes into account the interaction between internal (collusion) risks and external (default) risks in the optimal design of the internal organization as well as of the credit contracts. We investigate this question in two settings. In the first one, we adopt the standard assumption that the agent is always willing to collude (is corruptible) if that increases his monetary payoff. In the second one, he is corruptible with some probability only, and honest otherwise. A novel feature of our approach is to allow for screening among corruptible and honest agents. We find that if the probability that the agent is honest is sufficiently large, collusion occurs in equilibrium. ∗Boston College. [email protected]. I wish to thank Guillermo Alger, Juan Carrillo, Antoine Faure-Grimaud, Jean-Jacques Laffont, David Martimort, Fausto Panunzi, and Jean Tirole for their comments. Financial support from The Royal Swedish Academy of Sciences (Karl Langenskiölds fond), the Stockholm School of Economics, and the French Ministry of Foreign Affairs is thankfully acknowledged.