Working Paper: CEPR ID: DP10925
Authors: Elisabetta Iossa; David Martimort
Abstract: We analyze risk allocation and contractual choices when public procurement is plagued with moral hazard, private information on exogenous shocks, and threat of corruption. Complete contracts entail state-contingent clauses that compensate the contractor for shocks unrelated to his own effort. By improving insurance, those contracts reduce the agency cost of moral hazard. When the contractor has private information on revenues shocks, verifying messages on shocks realizations is costly. Incomplete contracts do not specify state-contingent clauses, thereby saving on verifiability costs. This makes incomplete contracts attractive even though they entail greater agency costs. Because of private information on contracting costs, a public official may have discretion to choose whether to procure under a complete or an incomplete contract. When the public official is corrupt, such delegation results in incomplete contracts being chosen too often. Empirical predictions on the use of incomplete contracts and policy implications on the benefits of standardized contracts are discussed.
Keywords: corruption; incomplete contracts; moral hazard; principal-agent-supervisor model; public-private partnerships; risk allocation
JEL Codes: D23; D82; K42; L33
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| corruption (D73) | preference for incomplete contracts (D86) |
| preference for incomplete contracts (D86) | agency costs (G34) |
| corruption (D73) | increased risk of corruption (H57) |
| contracting costs (M55) | choice of contract type (complete vs. incomplete) (D86) |
| incomplete contracts (D86) | higher risk premiums for contractors (G22) |