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Hierarchies and Bureaucracies: On the Role of Collusion in Organizations

Author(s): Jean Tirole

Source: Journal of Law, Economics, & Organization, Vol. 2, No. 2 (Autumn, 1986), pp. 181-214

Published by: Oxford University Press

Stable URL: http://www.jstor.org/stable/765048.

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Hierarchies and Bureaucracies:

On the Role of Collusion in Organizations

JEAN TIROLE

Massachusetts Institute of Technology

1. INTRODUCTION This research derives its motivation (and borrows unrestrainedly)from sociological studies of collusive behavior in organizations. Like the sociology literature, it emphasizes that behavior is often best predicted by the analysis of group as well as individual incentives; and it gropes toward a precise definition of concepts such as "power," "cliques," "corporate politics," and (Crozier, 1963; Cyert and March;Dalton; Scott). It differsfrom "bureaucracy" this literature in that it tries to incorporatethe acquired knowledge of modern information economics into the analysis.

The research also borrows a considerable amount from the principal/agent paradigm of information economics. This paradigm, mainly developed for two-tier organizations, emphasizes the productive inefficiency associated with asymmetric informationand insurance motives (or limited liability constraints).' Formally, organizations can be seen as networks of overlapping or nested principal/agent relationships. A theme of the paper, however, is that the analysis of hierarchicalstructures does not boil down to a compounding of the basic inefficiency, due to the fact that going from the simple two-tier principal/agent structure to more complex ones introduces the possibility of

1. See, e.g., Ross; Mirrlees, 1975; Shavell; Holmstrom, 1979; and Grossman and Hart.

The author is very grateful to Kenneth Arrow, PatrickBolton, Eric Maskin, Oliver Williamson, various colleagues and students at MIT, and participantsat the LEO workshop at Yale Law School for helpful comments and suggestions, and to two anonymous referees for carefully executed reports. The research was supported by the French Planning Board (Commissariat Gen6ral au Plan), the National Science Foundation, and the Sloan Foundation.

Journal of Law, Economics, and Organization vol. 2, no. 2 Fall 1986 ? 1986 by Yale University. All rights reserved. ISSN 8756-6222

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collusion. This research departs from the existing information economics literature in that it views an organization as a network of contracts that interplay rather than as a single contract.

The consideration of coalitions in incentive theory certainly deserves some motivation. It raises the questions of how coalitions can form and whether they, in fact, do form. Part 2 reviews and classifies some evidence on the existence of coalitions and on their enforcement mechanism. The examples given there bring direct evidence that coalitions do matter. Since the emergence of coalitions ought to be anticipated at the organization design stage, the mere observation of real-worldcollusive behavior understates their significance.

Part 3 develops a simple three-tier principal/supervisor/agentmodel. The agent is the productive unit. He makes an unobservable decision, called "effort," which, together with an exogenous productivity shock, affects the principal's profit. Productivity can be low or high. Neither the level of productivity nor the level of effort is observed by the principal. The supervisor's role is to obtain more information about the agent's activity than is available to the principal. He is a mere conduit; his supervisory effort is assumed exogenous in order to focus on the transmission of information. He observes either the true level of productivity (and then has verifiable evidence about it) or nothing. His degree of freedom is whether to report to the principal when he observes the productivity (given that he can claim to have observed nothing).

The effect of coalitions on the optimal incentive scheme is then examined with reference to the supervisor/agent coalition. In addition to the usual incentive compatibility and individual rationalityconstraints, new constraints must be introduced. The supervisor here acts naturallyas an advocate for the agent. More generally, however, all types of coalitions need to be considered.

The relevant coalition occurs at a "nexus of informed parties," that is, within a group of parties that can manipulate the information received by the rest of the organization.





Part 4 suggests some implications of coalitions for organizationalbehavior.

Concluding remarks are offered in part 5.

2. COALITIONS AND COVERT TRANSFERS

HIERARCHIES

Vertical structures in this paper are represented by three-layer hierarchies:

principal/supervisor/agent.The roles of the three parties will be described in detail; for the moment, it suffices to think of the principal as the owner of the structure or as the buyer of the agent's product, of the agent as a party picking a productive action affecting the principal, and of the supervisor as a party

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collecting information to help the principal control the agent. Like the twotier representation of the classic principal/agent model, this three-tier description is a convenient abstraction. Most organizations are more complex than the idealization considered here. First, one can easily think of higherorder vertical structures. Second, horizontal elements can be superimposed on the vertical frame. For example, the supervisor may monitor several agents (see part 4), or the agent may be monitored by several supervisors.

The evidence supplied in the next section focuses on collusion within a firm A prototypical example concerns the hierarchy manager/foreman/worker.

It is clear, however, that these internal organization examples have much in common with collusive behaviors in other structures (even though these structures may differ in other respects: nature and flows of rewards, selection process for the agent, interplay with other horizontal and vertical elements, and so forth). Thus, I expect most conclusions will apply to hierarchies such as voter/government agency/defense contractor (or regulated firm),2 brass/ colonel/regiment, or economics profession/Ph.D. adviser/Ph.D. student.3 These examples motivate the following axioms, which underly the model presented in part 3.

Axiom 1: The principal, who is the owner of the vertical structure or the buyer of the good produced by the agent, or, more generally, the person who is affected by the agent's activity, lacks either the time or the knowledge required to supervise the agent.

Axiom 2: It is not efficient to divide the supervisory job among several supervisors.

Axiom 3: The supervisor lacks either the time or the resources required to run the vertical structure.

Axiom 3 is posited only to motivate at the current stage the presence of a principal (so that the vertical structure does not boil down to a two-tier one).

In the model I will actually dispense with Axiom 3 by allowing the principal to sell to the supervisor. Axiom 2 rules out the use of a team of supervisors. It can be justified either by a cost of duplication of the supervisory function or by a collusive behavior between supervisors. Some circumstances under which several supervisors can efficiently be used by the principal are described in part 4.3. Axiom 1 vindicates the supervisory function. It can be motivated by the possibilities that the principal overlooks and coordinates many agents or that he is technically unable to supervise the agent (in some of the examples

2. For example of collusion in procurement, see Scherer (1964: 100) and Williamson (1967a:

233); for the theory of regulatory capture, see Stigler and Posner; see also Rose-Ackermanand Caillaud et al.

3. To give a few other examples: shareholder/manager/worker; firm/auditor/manger;

investor/broker/firm; restaurant owner/maitre d'/waiter; Department of Defense/contractor/ subcontractor; train company/ticket inspector/passenger.

This content downloaded from 59.65.123.66 on Mon, 28 Oct 2013 01:51:38 AM All use subject to JSTOR Terms and Conditions 184 / JOURNAL OF LAW, ECONOMICS, AND ORGANIZATION 11:2, 1986 above, the introduction of a supervisor also helps solve the free rider problem associated with the supervision by several principals).

The model set up in part 3 will focus on the supervisory function by assuming that the supervisor has no management or production activity. This

assumption is restrictive. In general, the supervisor creates a joint output:

supervision of the agent and contribution to production. The productive part may involve the selection of the agent (for example, a contractor selects a subcontractor),the organizationand coordination of production and the supply of tools, and the advisory function. Focusing on the supervisory function enables me to make my main points without undue complexity. I do, however, feel that the interplay between the supervisory and production functions is an important question, which I shall tackle in part 5.

2.2. COALITIONS

AND COVERTTRANSFERS

The startingpoint and the tangible effect of the coalition is the manipulationof the information received by the principal. There are several ways in which informationmay be manipulated: the existing evidence may be concealed or distorted, or the evidence may not be created. Several examples below will illustrate these three possibilities.

Second, the object of the coalition is to benefit one or several members of the coalition. We can distinguish between one-sided favors-one member manipulates the information to the benefit of another member-and shared favors-the manipulation benefits both members. One-sided favors usually go with an explicit or implicit promise of a counterbalancing favor from the beneficiary of the original favor to the other member. The delivery of this promise can be simultaneous or delayed.

The evidence on coalitions and covert transfers I now present is based on sociological studies of the internal organization of firms. In particular, I rely heavily on the very insightful work ofCrozier and Dalton,4 to whom I refer for more details. The general observation is that it is usually hard to obtain information from the intermediate levels of a hierarchy. Both Crozier and Dalton insist that very often common sense directs the controller to falsifyhis informationto allow the monitored group to obtain better results;5that is, the controller is not in a position that allows him to give trustworthyinformation.

Both sociologists strongly emphasize the existence of coalitions (Crozier talks about "clansand groups of members of different categories"and Dalton about "cliques. ")6 As mentioned earlier, one way of manipulatingthe informationis to ignore

4. I am grateful to Woody Powell for the Dalton reference.

5. See, e.g., Crozier, 1963: 51, 52, 56, and 280.

6. See also Selznick's idea that expertise tends to create a caste spirit and temptations of collusion with groups that depend on that expertise.

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