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Agency in Project Screening and Termination Decisions: Why is Good Money Thrown after Bad?

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Author Info

  • Chong-en Bai

    ()
    (Boston College)

  • Yijang Wang

    (University of Minnesota)

Abstract

We construct an agency model in which the planner (agent) makes project starting and termination decisions on behalf of the state (principal) to reflect the practice of socialist economies. The model shows that asymmetric information between the state and the planner regarding the quality of projects started leads to the persistence of unprofitable projects in most cases. Since in the model it is assumed that the state's objective is to maximize economic profit and the state has full power to dictate and enforce the optimal contract, the finding of the model has the implication that hardening budget constraints in socialist economies is difficult even under an "ideal" setting when these economies are free of social considerations and political frictions.

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Bibliographic Info

Paper provided by Boston College Department of Economics in its series Boston College Working Papers in Economics with number 347..

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Length: 41 pages
Date of creation: 01 Jan 1997
Date of revision:
Handle: RePEc:boc:bocoec:347

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Web page: http://fmwww.bc.edu/EC/
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Keywords: Soft budget; agency; project screening and termination;

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References

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  1. Bardhan, Pranab & Roemer, John E., 1991. "Market Socialism," Department of Economics, Working Paper Series qt6c86h1r2, Department of Economics, Institute for Business and Economic Research, UC Berkeley.
    • Ortuna-Ortin, I. & Roemer, J.E. & Silvestre, J., 1990. "Market Socialism," Papers 355, California Davis - Institute of Governmental Affairs.
  2. Ma, Ching-To Albert, 1994. "Renegotiation and Optimality in Agency Contracts," Review of Economic Studies, Wiley Blackwell, vol. 61(1), pages 109-29, January.
  3. Qian, Yingyi, 1994. "Incentives and Loss of Control in an Optimal Hierarchy," Review of Economic Studies, Wiley Blackwell, vol. 61(3), pages 527-44, July.
  4. Shleifer, Andrei & Vishny, Robert W, 1986. "Large Shareholders and Corporate Control," Journal of Political Economy, University of Chicago Press, vol. 94(3), pages 461-88, June.
  5. Fudenberg, Drew & Tirole, Jean, 1990. "Moral Hazard and Renegotiation in Agency Contracts," Econometrica, Econometric Society, vol. 58(6), pages 1279-1319, November.
  6. Bengt Holmstrom, 1981. "Moral Hazard in Teams," Discussion Papers 471, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  7. Pranab Bardhan & John E. Roemer, 1992. "Market Socialism: A Case for Rejuvenation," Journal of Economic Perspectives, American Economic Association, vol. 6(3), pages 101-116, Summer.
  8. Grossman, Sanford J. & Hart, Oliver D., 1986. "The Costs and Benefits of Ownership: A Theory of Vertical and Lateral Integration," Scholarly Articles 3450060, Harvard University Department of Economics.
  9. Holmstrom, Bengt & Ricart i Costa, Joan, 1986. "Managerial Incentives and Capital Management," The Quarterly Journal of Economics, MIT Press, vol. 101(4), pages 835-60, November.
  10. Holmstrom, Bengt & Tirole, Jean, 1993. "Market Liquidity and Performance Monitoring," Journal of Political Economy, University of Chicago Press, vol. 101(4), pages 678-709, August.
  11. Bengt Holmstrom, 1979. "Moral Hazard and Observability," Bell Journal of Economics, The RAND Corporation, vol. 10(1), pages 74-91, Spring.
  12. Andrei Shleifer & Robert W. Vishny, 1994. "The Politics of Market Socialism," Journal of Economic Perspectives, American Economic Association, vol. 8(2), pages 165-176, Spring.
  13. Calvo, Guillermo A & Wellisz, Stanislaw, 1978. "Supervision, Loss of Control, and the Optimum Size of the Firm," Journal of Political Economy, University of Chicago Press, vol. 86(5), pages 943-52, October.
  14. Schaffer, Mark E., 1989. "The credible-commitment problem in the center-enterprise relationship," Journal of Comparative Economics, Elsevier, vol. 13(3), pages 359-382, September.
  15. Joseph E. Stiglitz, 1996. "Whither Socialism?," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262691825.
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Cited by:
  1. J. Kornai & E. Maskin & G. Roland., 2004. "Understanding the Soft Budget Constraint," VOPROSY ECONOMIKI, N.P. Redaktsiya zhurnala "Voprosy Economiki", vol. 11.
  2. Mark E. Schaffer, 1997. "Do Firms in Transition Economies have Soft Budget Constraints? A Reconsideration of the Concepts and Evidence," CERT Discussion Papers 9720, Centre for Economic Reform and Transformation, Heriot Watt University.

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