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Water Management in France: Delegation and Irreversibility

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Author Info

  • Ephraim Clark

    ()
    (Middlesex University Business School)

  • Gérard Mondello

    ()
    (LATAPSES / CNRS, Dept. OIEE)

Abstract

The problem that we address in this paper stems from the trend to delegation in the water management field. It refers to the municipality’s negotiating disadvantage in the face of cartelized water management firms that makes delegation, once undertaken, virtually irreversible. We show why the characteristics of the delegation auction render is useless as a tool for collective welfare maximization. We also show that the remaining tool for achieving collective welfare maximization, i.e. the municipality’s right to revoke delegation and return to direct management, is also ineffective due to a lack of credibility that is essentially financial in nature. Thus, if the credibility of revocation could be restored, the municipality’s bargaining power could also be restored. Using standard methods of stochastic calculus, we model the municipality’s right of revocation as a call option held by the municipality. We show that the key variable for the value of this option, and thus for the municipality’s position, is the exercise price, which is partly determined by objective economic criteria and partly by legal and institutional conventions. We show that community welfare maximisation occurs at the point where the exercise price is determined exclusively by objective economic criteria. Since the delegated firm as a simple agent has the right to abrogate the contract if delegation becomes unprofitable, we then model this right as a put option held by the firm. Its value also depends to a large extent on the exercise price, which is partly determined by objective economic criteria and partly by legal and institutional conventions. Combining the exercise points of the two options enables us to determine the price-profit interval over which delegation will be acceptable to both parties. We conclude that the optimal interval will be the one where the exercise prices are determined entirely by objective economic criteria.

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Bibliographic Info

Article provided by Universidad del CEMA in its journal Journal of Applied Economics.

Volume (Year): III (2000)
Issue (Month): (November)
Pages: 325-352

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Handle: RePEc:cem:jaecon:v:3:y:2000:n:2:p:325-352

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Related research

Keywords: Water management; Delegation; Insurance mechanisms; Technological Changes; Real Options;

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References

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  1. Zeitouni, Naomi & Becker, Nir & Shechter, Mordechai, 1994. "Models of water market mechanisms and an illustrative application to the Middle East," Resource and Energy Economics, Elsevier, vol. 16(4), pages 303-319, November.
  2. Laffont, J.J., 1993. "Regulation of Pollution with Asymmetric Information," Papers 93.290, Toulouse - GREMAQ.
  3. Arrow, Kenneth J & Fisher, Anthony C, 1974. "Environmental Preservation, Uncertainty, and Irreversibility," The Quarterly Journal of Economics, MIT Press, vol. 88(2), pages 312-19, May.
  4. Steven Shavell, 1983. "Liability for Harm Versus Regulation of Safety," NBER Working Papers 1218, National Bureau of Economic Research, Inc.
  5. Steven Shavell, 2003. "Economic Analysis of Accident Law," NBER Working Papers 9694, National Bureau of Economic Research, Inc.
  6. Baumol, William J, 1986. "On the Possibility of Continuing Expansion of Finite Resources," Kyklos, Wiley Blackwell, vol. 39(2), pages 167-79.
  7. Ephraim Clark & Gérard Mondello, 2000. "Resource Management and the Mayor's Guarantee in French Water Allocation," Environmental & Resource Economics, European Association of Environmental and Resource Economists, vol. 15(2), pages 103-113, February.
  8. Kenneth Hendricks & Robert Porter, 1989. "Collusion in Auctions," Discussion Papers 817, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  9. Kolstad, Charles D & Ulen, Thomas S & Johnson, Gary V, 1990. "Ex Post Liability for Harm vs. Ex Ante Safety Regulation: Substitutes or Complements?," American Economic Review, American Economic Association, vol. 80(4), pages 888-901, September.
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Citations

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Cited by:
  1. Urs Meister, 2004. "Franchise Bidding in the Water Industry- Auction Schemes and Investment Incentives," Working Papers 0033, University of Zurich, Institute for Strategy and Business Economics (ISU).
  2. Dosi, Cesare & Easter, K. William, 2000. "Water Scarcity: Economic Approaches To Improving Management," Working Papers 14461, University of Minnesota, Center for International Food and Agricultural Policy.
  3. Clark, Ephraim & Easaw, Joshy Z., 2007. "Optimal access pricing for natural monopoly networks when costs are sunk and revenues are uncertain," European Journal of Operational Research, Elsevier, vol. 178(2), pages 595-602, April.
  4. Urs Meister, 2005. "Do welfare maximising water utilities maximise welfare under common carriage?," Others 0505001, EconWPA.

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