Using Cost Observation to Regulate Bureaucratic Firms
AbstractWe 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 InfoPaper provided by Universidade do Porto, Faculdade de Economia do Porto in its series FEP Working Papers with number 304.
Length: 36 pages
Date of creation: Dec 2008
Date of revision:
Procurement; Regulation; Adverse selection; Moral hazard; Bureaucracy;
Find related papers by JEL classification:
- D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
- H41 - Public Economics - - Publicly Provided Goods - - - Public Goods
- H51 - Public Economics - - National Government Expenditures and Related Policies - - - Government Expenditures and Health
- I11 - Health, Education, and Welfare - - Health - - - Analysis of Health Care Markets
This paper has been announced in the following NEP Reports:
- NEP-ALL-2009-01-03 (All new papers)
- NEP-CTA-2009-01-03 (Contract Theory & Applications)
- NEP-REG-2009-01-03 (Regulation)
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