Monitoring and Collusion with “Soft” Information

In the standard principal-supervisor-agent model with collusion, Tirole (1986) shows that employing a supervisor is profitable for the principal if the supervisor’s signal of the agent’s cost of production is “hard” (i.e., verifiable but hideable). Anecdotal evidence suggests that information is sometimes “soft” (i.e., unverifiable). We show that, in fact, it is profitable to employ a supervisor when information is “soft” even though the three parties can collude. Therefore, standard applications of the principal-supervisor-agent model to regulation and auditing have more scope than previously thought.