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Public-private contracting under limited commitment

  • Daniel Danau

    (UFR de sciences économiques et de gestion, Université de Caen Basse-Normandie, CREM-CNRS, UMR 6211)

  • Annalisa Vinella

    (Università degli Studi di Bari "Aldo Moro", Italy)

A government delegates construction and operation of an essential facility to a private firm. When parties sit at the contracting table, they are uncertain about the operating cost. At the construction stage, the firm can improve its distribution by exerting some non-contractible effort. As soon as the facility is in place, the firm learns the realized cost privately. In case any of the parties breaks down the relationship and the firm is replaced during the operation phase, the government bears a cost that is more important the earlier the interruption, relative to the stipulated duration. We show that, under limited commitment, the optimal full-commitment allocation is implementable if and only if the firm holds some minimum amount of own funds that can be destined to the project, it is able to borrow funds for that specific project, and the replacement cost is sufficiently high. Implementation is made by instructing the firm to invest some intermediate amount of own and borrowed funds, by conditioning the loan guarantee (provided under the aegis of a third party not suffering from commitment problems) on the outcome of the potential renegotiation process between the government and the firm, and by setting duration neither too short nor too long. Making duration contingent on the realized operating cost helps the government lessen the more concerning between moral-hazard and commitment problems.

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Paper provided by Center for Research in Economics and Management (CREM), University of Rennes 1, University of Caen and CNRS in its series Economics Working Paper Archive (University of Rennes 1 & University of Caen) with number 201227.

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Date of creation: Jun 2012
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Handle: RePEc:tut:cremwp:201227
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