This paper discusses the origins of the transaction costs in side-contracting. In Tirole (1986)'s model of collusion with a risk averse supervisor, the optimal collusion-proof contract trades-o® coalitional incentives against an insurance motive. We characterize the corresponding agency cost and allocative distortions. Identifying this contractual outcome with Tirole (1992)'s model of collusion with exogenous transaction costs provides foundations for those transaction costs.
Transaction costs of collusion are stake-dependent, linked to the economic environment and function of the colluding agents' degrees of risk preferences. We provide several applications of this theory of transaction costs for organizational design (vertical integration, design of supervisory structures and side-contracting under uncertainty).
Key Words: Supervision, collusion, stake-dependent transaction costs.
Jel Classi¯cation: D82, G14, G32, L51
