Local public works and intergovernmental transfers under asymmetric information

Abstract

This paper studies local public works decisions in a hierarchical setting under bidimensional asymmetric information. A local authority plans to undertake a public work and delegates its construction to a firm. The federal government decides whether to fund the project, without being informed of either the project’s benefit or the constructor’s efficiency. The local authority knows these values. To deal with this informational gap, the federal government designs a public work contract, specifying transfers to the local authority and to the firm. We show under which circumstances cost-sharing and compensations emerge as incentive devices. Then we identify which projects are effectively constructed. More works with low (high) benefits are undertaken (shut down) than under full-information.