Abstract

This paper features a continuum of firms that apply for a permit and randomly get matched with a potentially corrupt bureaucrat. Although firms have the reporting option, they prefer paying low enough bribes to avoid reporting costs. Hence, full-corruption is the unique equilibrium. Furthermore, the value of entry is always negative for the marginal firm. Hence, there will be no entry. If firms are offered sufficiently high rewards for reporting, corruption could be eliminated. However, a reward high enough to uproot corruption would lead to false accusations. Thus, rewarding could help reduce corruption, but only if the market is viable in its absence. The paper also argues that in the presence of corruption, the shadow economy and the official economy are complements. Similarly, formal punishment for corruption and the moral cost of corruption could complement each other.