Failure to Collude in the Presence of Asymmetric Information

Abstract

In this paper, we study the transaction costs in coalition formation created by asymmetric information in a setting in which two agents producing complementary inputs can collude. They are assumed to have correlated private information and be protected by limited liability. We first characterize the optimal mechanism without collusion. The optimal quantity schedule is decreasing for negative and weak positive correlation while it is not monotonic for strong positive correlation. When collusion takes place under complete information between the agents, the principal can never implement a non-monotonic quantity schedule in a collusion-proof way. However, we show that when collusion takes place under asymmetric information, by taking advantage of the transaction costs created by asymmetric information, the principal can implement the optimal mechanism without side-contracting in a collusion-proof way without any loss regardless of the sign and the degree of correlation.