Less Risk, More Effort: Demand Risk Allocation in Incomplete Contracts
Laure Athias () and
Raphael Soubeyran ()
Working Papers from LAMETA, Universtiy of Montpellier
This article investigates the allocation of demand risk within an incomplete contract frame- work. We consider an incomplete contractual relationship between a public authority and a private provider (i.e. a public-private partnership), in which the latter invests in non-verifiable cost-reducing efforts and the former invests in non-verifiable adaptation efforts to respond to changing consumer demand over time. We show that the party that bears the demand risk has fewer hold-up opportunities and that this leads the other contracting party to make more effort. Thus, in our model, bearing less risk can lead to more effort, which we describe as a new example of ‘counter-incentives’. We further show that when the benefits of adaptation are important, it is socially preferable to design a contract in which the demand risk remains with the private provider, whereas when the benefits of cost-reducing efforts are important, it is socially preferable to place the demand risk on the public authority. We then apply these results to explain two well-known case studies.
Pages: 19 pages
Date: 2012-06, Revised 2012-06
New Economics Papers: this item is included in nep-bec, nep-cta and nep-mic
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http://www.lameta.univ-montp1.fr/Documents/DR2012-20.pdf First version, 2012 (application/pdf)
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Persistent link: https://EconPapers.repec.org/RePEc:lam:wpaper:12-20
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