Using Cost Observation to Regulate Bureaucratic Firms

Ana Borges () and Joao Correia-da-Silva

FEP Working Papers from Universidade do Porto, Faculdade de Economia do Porto

Abstract: We study regulation of a bureaucratic provider of a public good in the presence of moral hazard and adverse selection. By bureaucratic we mean that it values output in itself, and not only profit. Three different financing systems are studied - cost reimbursement, prospective payment, and the optimal contract. In all cases, the output level increases with the bureaucratic bias. We find that the optimal contract is linear in cost (fixed payment plus partial cost-reimbursement). A stronger preference for high output reduces the tendency of the firm to announce a high cost (adverse selection), allowing a more powered incentive scheme (a lower fraction of the costs is reimbursed), which alleviates the problem of moral hazard.

Keywords: Procurement; Regulation; Adverse selection; Moral hazard; Bureaucracy (search for similar items in EconPapers)
JEL-codes: D82 H41 H51 I11 (search for similar items in EconPapers)
Pages: 36 pages
Date: 2008-12
New Economics Papers: this item is included in nep-cta and nep-reg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:por:fepwps:304

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