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Corruption is a phenomenon that is ubiquitous, but the extent and the form differ across countries. According to Transparency International, the Corruption Perception Index (CPI) in year 2001 varied from 0.4 to 9.9 (10 is completely corruption free). The average score for the 91 countries surveyed was 4.76 (with a standard deviation of 2.39). Why is there so much cross-country difference? Why are some countries virtually corruption free, but are others fraught with corruption?

Analysis of management compensation has focused on the principal — agent problem. We address the problem confronting owners who must choose a manager without knowing the productivity of individual managers. We find performance contingent contracts may result in a separating equilibrium in which high productivity managers accept contracts low productivity managers find unacceptable.