Contract Choice, Incentives, and Political Capture in the Public Sector

Abstract

We consider a framework of contractual interactions between public transport authorities and transport operators. We estimate simultaneously the contract choice by the authorities and the effect of regulation on the cost-reducing activity of the operators. We test whether the current regulatory schemes are the observable items of a complex menu of contracts, as proposed by Laffont and Tirole. We suggest that the generation process of the data we have in hand is better explained by a regulatory framework where an unsophisticated regulator is politically motivated. We show how these political preferences shape the contract choice and we shed light on how operating costs are affected. On average, operators’ costs are 12.1% lower under fixed-plus regimes, compared to the cost-plus cases.

Keywords: Contract choice, Cost reduction, Incentives, Public transit

JEL Classification: C51, L51