"Watch-dogs" vs. supervisor-agent collusion: an economic theory of codes of conduct for public administrators

In this essay I suggest a first-best solution to the collusion problem in a three-levels principal-supervisor-agent hierarchy (Tirole 1986, Laffont-Tirole 1993) in the context of a repeated games model. I introduce a new player in the component game i.e. a group of consumers which is also modelled as the constituency of the principal. An ex ante incomplete constitutional contract of authorisation links the principal to the group of consumer. At the next move in the game the group of consumers has a choice on the level of support and compliance to the principal’s authority, which I intend as a specific investment. Due to the incompleteness of contracts problem, according to the economic theory of corporate culture (Kreps 1990) and code of ethics (Sacconi 1997), the principal may only announce a code of basic principles of good administration, being not automatically enforceable. In the repeated game among the three levels hierarchy and an infinite series of short-lived groups of consumers/supporters, I prove by a reputation effects construction (Fudenberg-Levine 1989, 1992) that the first best contract offered by the principal to the supervisor and the agent is part of a self-enforcing equilibrium profile making possible to the principal to get a payoff that approximates the Stakelberg payoff in nearly all the component games.