Signaling and the Design of Delegated Management for Public Utilities

We propose a theory explaining the shape of contracts between local governments and the contractors they hire to run public facilities on their behalf. Governments are privately informed over the quality of the facility and risk-averse while risk-neutral contractors are subject to a moral hazard problem. We show how the design of the contract signals the asymmetric information parameter. The higher the quality of the network, the higher the marginal return and the greater the share of operating risk kept by the government. This reduces the agent’s marginal incentives, creating a trade-off between signalling and moral hazard. This trade-off is analyzed in different contexts allowing for risk-aversion on the agent’s side, double moral hazard and political economy issues. Lastly, a model of delegated signalling is developed highlighting the difficulty of designing separating contracts when governments are under the countervailing influences of both the contractors and the voters.