Costs of Engaging in Corruption: Equilibrium with Extortion and Framing

Abstract

This paper presents a three-tier law enforcement model in which an inspector monitors a firm's discharge of waste and reports it to a regulator. The inspector may engage in three forms of corruption - bribery, extortion and framing - with two types of costs: the cost of distorting information against the firm and the cost of side-transfer. In contrast with the earlier literature on corruption, we show that not only bribery but also extortion and framing may occur in equilibrium, even when all the forms of corruption could be deterred. We also find that higher costs of engaging in corruption may result in lower social welfare. Although these costs make engaging in corruption more difficult and hence more easily deter corruption, when corruption occurs in equilibrium, the costs cause wastage of scarce resources from society's point of view. This analysis also provides an explanation of why corruption is more pervasive in less developed countries.