Corruption in Privatization and Governance Regimes

We consider the choice to privatize the provision of a public good in a hierarchical model with three layers: a Central Government, a decentralized agency and a (private or public) manager. In a good governance regime the privatization can be devolved upon the decentralized agency while it cannot when the governance is bad. There are two types of information asymmetries: managers are privately informed of their efficiency in reducing costs (and quality) and only the decentralized agency knows the social cost of a lower grade good. We show that corruption is always detrimental to welfare when governance is good but it could be beneficial otherwise.