Abstract
In this paper, we provide new theoretical insights about the role of collusion in organizational hierarchies by combining the standard principal–supervisor–agent framework with a theory of social preferences. Extending Tirole’s (J Law Econ Organ 2(2):181–214, 1986) model of hierarchy with the inclusion of Fehr and Schmidt (Q J Econ 114(3):817–868, 1999) type of other-regarding preferences, the links between inequity aversion, collusive behavior and changes in optimal contracts are studied. It turns out that other-regarding preferences do change the collusive behavior among parties depending on the nature of both agent’s and supervisor’s other-regarding preferences. The most prominent impact is on the optimal effort levels. When the agent is inequity averse, the principal can exploit this fact to make agent exert higher effort level than she would otherwise. In order to satisfy the participation constraint of the supervisor, the effort level induced for the agent becomes lower when the supervisor is status seeker, and it is higher when the supervisor is inequity averse.
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