Sweet Lemons: Mitigating Collusion in Organizations

We show that mechanisms which generate endogenous asymmetric information fully mitigate collusion. In our model, an agent has private information and a supervisor observes a signal that is correlated with the agent’s type. Agent and supervisor can form collusive side agreements. We study the implementation of social choice functions that condition on the agent’s type and the supervisory signal. Our main result establishes that any social choice function that is implementable if the signal is public can also be implemented when the signal is private information and collusion is possible. Despite collusion, the signal is obtained for free, i.e., the supervisor does not receive an information rent. Our mechanism breaks collusion via endogenous creation of asymmetric information between agent and supervisor. The associated bargaining frictions prevent formation of collusive agreements, similar to the trade failure in the classical lemons market.