Incentives to Cheat and Principal's Incentives to Decrease Cheating

We develop a formal principal-agent framework analogous to the instructor-student relationship in order to examine students’ incentives to cheat and instructor’s incentives to decrease cheating. We consider a risk neutral principal (instructor) and two risk neutral agents (students) that interact, coordinate but also chose private strategies. We try to answer the question if it is preferable to mix agents of different abilities or segregate them, not only from the perspective of the principal but also from an efficiency aspect. We conclude that segregation is optimal from both points of view. Our analysis shows that the relationships within the triangle “principal – high ability agent – low ability agent” are governed by a system of externalities. First, there is a horizontal externality between agents. Second, there is a vertical externality between the principal and the agents that can also have effects on the behavior of the latter. In most models, the optimality of segregation trivially results from synergy effects between the agents assumed in the production function. In our model we do not assume any covariance of outputs, thus, the optimality of segregation occurs solely due to the horizontal externality between agents.