Collusion, Turnover, and Efficiency Wages in Organization

Abstract

Using reputation as a self-enforcing mechanism, a dynamic model with one principal and two agents is developed to analyze the effect of collusion possibility on the structure of organization. The stage game played by the agents has a prisoner's dilemma structure. so that collusion is a dominated action. In a long-term relationship, however, the agents can collude as long as future benefits are sufficient. Without relying on any precommitment for the principal's incentive scheme, we found that costly rotation of the agents (reducing future benefits of collusion) and paying a wage higher than the market-clearing wage are optimal for the principal when monitoring technology is imperfect and the cost of replacing the agents is small. The optimal structure of organization in terms of wages and rotating schemes is also discussed.