Investment and Risk-Taking in Procurement and Regulation

This note analyses investment and risk-taking in a simple agency model of public regulation/procurement borrowed from Laffont & Tirole (1993). We show that the principal will overinvest or underinvest depending on whether investment is marginally more productive in bad or in good states. Due to the incentive problem investment risk will be avoided even though all parties are risk-neutral. Apparently, this 'excessive' risk-aversion extends to a large class of agency problems in organization theory and finance