Hierarchical contracting in grant decisions: ex-ante and ex-post evaluation in the context of the EU Structural Funds.

This paper presents a simple principal-supervisor-agent model of the investment game between a supranational player (the principal), such as the European Commission, a regional government (the supervisor), and a private firm (the executing agency) . The EC is a benevolent social welfare maximiser, the regional government has an objective function that combines private benefits to politicians and the welfare of their constituency, the agent is a utility maximiser. The latter can be of a high or low efficiency type, and the operative cost, observable ex post, depends upon this binary technology and managerial effort, also unobservable. The EC offers a matching capital grant to the firm (as it does with the EU Structural Funds), intended to cover part of the investment cost of an otherwise unprofitable project. The regional government offers the remaining share of the subsidy. If the firm claims to be inefficient, the EC can send with some probability an ex-post evaluator and there is a penalty if she discovers that it is of the efficient-type. Moreover the regional government can collaborate with the EC to disclose additional information it may have on the firm, but it needs to be given a reward not to collude with the firm, that is in turn willing to offer a private benefit to the regional government to conceal unfavourable evidence. We show that the role of these providers of additional information is essential to reducing the value of the grant and in improving the inefficiencies caused by asymmetric information and the grant decision stage. The paper suggests that the EC should include ex-post evaluation, currently provided by the Structural Funds regulations, within regional planning contracts for infrastructure investment; and that regional governments should be offered a reward for disclosing additional information on the firm technology (ex-ante supervision).