"Friendships" in Vertical Relations

It has been argued that collusion among the members of an organization or a vertical structure creates efficiency losses, and hence should be prevented. This paper shows that whenever collusion takes the form of co-insurance agreements, here called `friendships', among the members of a vertical structure this may not be the case. Indeed, in such a case, collusion yields only a redistribution of surplus among the members of the vertical structure. Hence, its efficiency costs may be reduced by allowing these `friendships' to take place, rather than preventing them, and accounting for the redistribution in the design of the optimal incentive scheme.