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Using Cost Observation to Regulate Bureaucratic Firms

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  • Ana Pinto Borges

    ()
    (Faculdade de Economia, Universidade do Porto)

  • João Correia-da-Silva

    ()
    (CEMPRE and Faculdade de Economia, Universidade do Porto)

Abstract

We study regulation of a bureaucratic provider of a public good in the presence of moral hazard and adverse selection. By bureaucratic we mean that it values output in itself, and not only profit. Three different financing systems are studied - cost reimbursement, prospective payment, and the optimal contract. In all cases, the output level increases with the bureaucratic bias. We find that the optimal contract is linear in cost (fixed payment plus partial cost-reimbursement). A stronger preference for high output reduces the tendency of the firm to announce a high cost (adverse selection), allowing a more powered incentive scheme (a lower fraction of the costs is reimbursed), which alleviates the problem of moral hazard.

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Bibliographic Info

Paper provided by Universidade do Porto, Faculdade de Economia do Porto in its series FEP Working Papers with number 304.

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Length: 36 pages
Date of creation: Dec 2008
Date of revision:
Handle: RePEc:por:fepwps:304

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Keywords: Procurement; Regulation; Adverse selection; Moral hazard; Bureaucracy;

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  1. Laffont, Jean-Jacques & Tirole, Jean, 1986. "Using Cost Observation to Regulate Firms," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 94(3), pages 614-41, June.
  2. Roger B. Myerson, 1977. "Incentive Compatability and the Bargaining Problem," Discussion Papers, Northwestern University, Center for Mathematical Studies in Economics and Management Science 284, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  3. David P. Baron & David Besanko, 1984. "Regulation, Asymmetric Information, and Auditing," RAND Journal of Economics, The RAND Corporation, vol. 15(4), pages 447-470, Winter.
  4. Jean-Jacques Laffont & Jean Tirole, 1993. "A Theory of Incentives in Procurement and Regulation," MIT Press Books, The MIT Press, The MIT Press, edition 1, volume 1, number 0262121743, December.
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Cited by:
  1. Ana Pinto Borges & Didier Laussel & João Correia-da-Silva, 2013. "Multidimensional Screening with Complementary Activities: Regulating a Monopolist with Unknown Cost and Unknown Preference for Empire Building," Games, MDPI, Open Access Journal, MDPI, Open Access Journal, vol. 4(3), pages 532-560, September.

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