Leonardo Felli and J M Villas-Boas

Published September 1996

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It has been argued that collusion among the members of an organization or a vertical structure creates efficiency losses, and hence should be prevented. This paper shows that whenever collusion takes the form of co-insurance agreements, here called ?friendships?, among the members of a vertical structure this may not be the case. Indeed, in such a case, collusion yields only a redistribution of surplus among the members of the vertical structure. Hence, its efficiency costs may be reduced by allowing these ?friendships? to take place, rather than preventing them, and accounting for the redistribution in the design of the optimal incentive scheme.