Asymmetry of Information, Regulatory Lags and Optimal Incentive Contracts: Theory and Evidence

Abstract

procurements. The procurement process and the equilibrium bidding behavior is modelled in sections II and III and the effect of contract parameters and other structural variables on expected procurement costs are explicitly derived. The existing models are enriched by incorporating a technology for cost reduction where the investment in cost reduction made by the contractor is unobservable to the utility. In the presence of such informational asymmetry, the optimal incentive parameter to be used is derived in terms of information available to the utility. In section IV the effects of changing contractual parameters and other structural variables (number of contractors bidding, the riskiness of the production process, etc.) on equilibrium bidding behavior and ex post cost reduction incentives are derived. In section V we relate some of the implications of our model to a sample