In Principal-Agent problem, agent serves (or fails to serve) the interests of a principal. The action of agent on behalf of his principal requires some discretion. There are situations that include 3rd party players (persons or corporate identities) who gains/loses by the action of the agent. There are regulations, violation of which causes a possibility of a cost (as a penalty) being coerced upon the violator.
An agent is personally corrupt if he knowingly sacrifices his principal’s interest to his own, that is, if he betrays his trust. He is officially corrupt if, in serving his principal’s interest, he knowingly violates a rule, that is, acts illegally or unethically, albeit in his principal’s interest.
The corruption features the conflict between the public interest and the market. Widespread and substantial bribery has a significant influence to transform democratic/meritocratic based governmental procedure into one based on willingness-to-pay.
Perfect competition theory focuses on the impersonality of all market dealings. A producer will sell to customers irrespective of their age, gender, or appeal. Similar to the market, the ideal bureaucrat makes decisions, policies on the basis of meritocratic, objective measures irrespective of personal, ethnic or family ties. However, bribes likely can replace these meritocratic principles with an (im)-personal willingness-to-pay procedure; contrariwise, for the newcomers the payoff may be a mean to obtain power in society. From this perspective, we may analyze bribery relative to a system without bribery.
In a bureaucratic system where political and economic decisions are organized in a complete hierarchy, the activities of those organizations are imperfectly coordinated and the different incentives create principal-agent problem. Imperfect coordination might occur due to few reasons (Powell, 1977): 1) distorted information as it travels up the hierarchy; 2) time consuming and costly processing of the information at higher levels; 3) imperfect control of subordinates by their superiors; 4) influence of multiple superiors and of actions for alternative states of the environment on subordinate’s ability to fulfill the plan; etc.
When representatives are elected, they care about being re-elected, as well they likely care about their income. In case of a low re-election chance, having no moral qualms about accepting payoffs, politician will be willing to b compensated by the bribe. Ceteris paribus, we may assume that the bureaucrats with the minimum reservation bribes are the ones that are certain of success or defeat. Considering that those payoffs can be spent either on a re-election purposes or personal purposes, then all politicians may possibly be corruptible.
Bribes cannot exist in a perfectly competitive market, where supplier sells and buyers receive all they demand at the market price. In order for corruption to happen, market imperfections are required. The reason is that, if bribes are proposed, in return there should be an excess profit out of which the bribe is paid, and if bribe is accepted, either the agent’s superiors are informed about it or there is a lack of monitoring.
Illegal underground markets in the private sector arise when the institutional structure precludes owners from allocating their resources in a competitive market. All such illegal markets exist because government has attenuated or eliminated rights, preventing or altering the competitive free market allocation of resources.
In various economic contexts, buyer either pays bribes to obtain supplies, or receives bribes to accept an offer of supplier.
Dispensers of benefit and burdens
In order to control corruption, one way is that a competitive pressure can be introduced as a way of decreasing the payoffs to be received and discouraging bureaucrats from receiving bribes which are low relative to the risk of being detected and punished. For example, when a bureaucracy dispenses an unusual benefit, competition can be introduced by letting a candidate to reapply few times in the case of turn down by one official. If the cost of reapplication is small, the first official cannot demand bribes for the approval of application.
In order to prevent, the expected punishment for bribery must be linked to the marginal benefit from marginal increases in the payoff. Especially, the bribe-giver’s marginal punishment should be tied to the marginal increase in profit that a bribe makes possible, instead of the size of the bribe. Penalties set at a multiple of the bribe given may have little threatening effect on bribe-payers if the expected profits are larger.
In short, the role of competitive pressures in preventing corruption may be an important aspect of a strategy to deter the bribery of low-level officials, but requires a broad-based exploration of the impact of both organizational and market structure on the incentives for corruption facing both bureaucrats and their clients.