Using Cost Observation to Regulate Bureaucratic Firms
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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- Jean-Jacques Laffont & Jean Tirole, 1993. "A Theory of Incentives in Procurement and Regulation," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262121743, June.
- Jean Tirole & Jean-Jaques Laffont, 1985.
"Using Cost Observation to Regulate Firms,"
368, Massachusetts Institute of Technology (MIT), Department of Economics.
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284, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
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- 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.
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