Public-private partnerships, incomplete contracts, and distributional fairness – when payments matter

The German energy sector’s transition toward the more distributed production of energy has given rise to various forms of decentralized energy production. Within the framework of decentralized infrastructure, the relation between the involved agents is often characterized by a high degree of social proximity. Thus, the spatial and social closeness usually emphasizes aspects of decision-making such as pro-social behavior that can have significant effects on the involved parties’ response to agency problems and their investment incentives. This essay applies behavioral economics’ finding on so-called social preferences to fundamental insights from incomplete contract theory regarding economic agents’ investment behavior. Specifically, it will be analyzed how a contractor’s investment incentives develop in a public-private partnership setting given incomplete contracts when the contractor disposes of preferences for distributional fairness. It will be shown that the investment incentives of the contractor are significantly different from those of the standard model assuming neoclassical preferences. Another important finding is that in contrast to the standard model in which only the allocation of property rights can set different investment incentives, payments can also influence an economic agent’s behavior when social preferences apply as the distribution of payments determines whether the psychological influences of envy or a sense of guilt are affecting the contractor.