Corruption, extortion, reputation and asymmetric information

This paper develops a simple reputational model that examines the situation of where a corrupt official attempts to extort a bribe from a firm. The game, between these two players, is repeated, giving us a two-period story. In, what I describe as the ‘pretending-to-be-heroic scenario’, the firm (a ‘soft’ firm) does not pay the bribe in the first period (as well as, not paying the bribe in the second period). If it was a one period-model this firm would pay the bribe, and, if the bribe was not paid, the official would carry out her threat. However, in the two-period model, with a pooling equilibrium, both types of firms behave like ‘hard’ firms in the first period (not paying the bribe and complaining if the threat is carried out). Since the official knows that either type of firm will complain, she does not carry out her threat. A necessary condition for this pooling equilibrium, is that, in the second period (if the official has not discovered the firm’s type) the parameters will be such, that the official will calculate that there would be an expected loss from carrying out her threat.