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Agency in Project Screening and Termination Decisions: Why is Good Money Thrown after Bad?

Chong-En Bai and Yijang Wang
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Yijang Wang: University of Minnesota

No 347., Boston College Working Papers in Economics from Boston College Department of Economics

Abstract: We construct an agency model in which the planner (agent) makes project starting and termination decisions on behalf of the state (principal) to reflect the practice of socialist economies. The model shows that asymmetric information between the state and the planner regarding the quality of projects started leads to the persistence of unprofitable projects in most cases. Since in the model it is assumed that the state's objective is to maximize economic profit and the state has full power to dictate and enforce the optimal contract, the finding of the model has the implication that hardening budget constraints in socialist economies is difficult even under an "ideal" setting when these economies are free of social considerations and political frictions.

Keywords: Soft budget; agency; project screening and termination (search for similar items in EconPapers)
JEL-codes: D82 P51 (search for similar items in EconPapers)
Pages: 41 pages
Date: 1997-01-01
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