Water Management in France: Delegation and Irreversibility

Ephraim Clark and Gerard Mondello

Journal of Applied Economics, 2000, vol. 3, 325-352

Abstract: The problem that we address in this paper stems from the trend to delegation in the water management field. It refers to the municipalityÂ’s negotiating disadvantage in the face of cartelized water management firms that makes delegation, once undertaken, virtually irreversible. We show why the characteristics of the delegation auction render is useless as a tool for collective welfare maximization. We also show that the remaining tool for achieving collective welfare maximization, i.e. the municipalityÂ’s right to revoke delegation and return to direct management, is also ineffective due to a lack of credibility that is essentially financial in nature. Thus, if the credibility of revocation could be restored, the municipalityÂ’s bargaining power could also be restored. Using standard methods of stochastic calculus, we model the municipalityÂ’s right of revocation as a call option held by the municipality. We show that the key variable for the value of this option, and thus for the municipalityÂ’s position, is the exercise price, which is partly determined by objective economic criteria and partly by legal and institutional conventions. We show that community welfare maximisation occurs at the point where the exercise price is determined exclusively by objective economic criteria. Since the delegated firm as a simple agent has the right to abrogate the contract if delegation becomes unprofitable, we then model this right as a put option held by the firm. Its value also depends to a large extent on the exercise price, which is partly determined by objective economic criteria and partly by legal and institutional conventions. Combining the exercise points of the two options enables us to determine the price-profit interval over which delegation will be acceptable to both parties. We conclude that the optimal interval will be the one where the exercise prices are determined entirely by objective economic criteria.

Keywords: Water management; Delegation; Insurance mechanisms; Technological Changes; Real Options (search for similar items in EconPapers)
JEL-codes: D44 D81 G13 O33 Q00 Q25 (search for similar items in EconPapers)
Date: 2000
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (10)

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Persistent link: https://EconPapers.repec.org/RePEc:cem:jaecon:v:3:y:2000:n:2:p:325-352

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