Water Management in France: Delegation and Irreversibility

Journal of Applied Economics, Vol. 3, No. 2, pp. 325-352, November 2000

Posted: 20 Jun 2004

See all articles by Ephraim Clark

Ephraim Clark

Middlesex University Business School

Gerard Mondello

CNRS, GREDEG CREDECO UMR 6227

Abstract

The problem that we address in this paper stems from the trend to delegation in the water management field. It refers to the municipality's negotiating disadvantage in the face of cartelized water management firms that makes delegation, once undertaken, virtually irreversible. We show why the characteristics of the delegation auction render is useless as a tool for collective welfare maximization. We also show that the remaining tool for achieving collective welfare maximization, i.e. the municipality's right to revoke delegation and return to direct management, is also ineffective due to a lack of credibility that is essentially financial in nature. Thus, if the credibility of revocation could be restored, the municipality's bargaining power could also be restored. Using standard methods of stochastic calculus, we model the municipality's right of revocation as a call option held by the municipality. We show that the key variable for the value of this option, and thus for the municipality's position, is the exercise price, which is partly determined by objective economic criteria and partly by legal and institutional conventions. We show that community welfare maximisation occurs at the point where the exercise price is determined exclusively by objective economic criteria. Since the delegated firm as a simple agent has the right to abrogate the contract if delegation becomes unprofitable, we then model this right as a put option held by the firm. Its value also depends to a large extent on the exercise price, which is partly determined by objective economic criteria and partly by legal and institutional conventions. Combining the exercise points of the two options enables us to determine the price-profit interval over which delegation will be acceptable to both parties. We conclude that the optimal interval will be the one where the exercise prices are determined entirely by objective economic criteria.

Keywords: Water management, delegation, insurance mechanisms, technological changes, real options

JEL Classification: D44, D81, Q00, Q25, O33, G13

Suggested Citation

Clark, Ephraim and Mondello, Gerard, Water Management in France: Delegation and Irreversibility. Journal of Applied Economics, Vol. 3, No. 2, pp. 325-352, November 2000, Available at SSRN: https://ssrn.com/abstract=556285

Ephraim Clark (Contact Author)

Middlesex University Business School ( email )

The Burroughs
London, NW4 4BT
United Kingdom

Gerard Mondello

CNRS, GREDEG CREDECO UMR 6227 ( email )

250 avenue Albert Einstein
Valbonne, Sophia Antipolis, 06560
France
+33-04-93 954327 (Phone)
+33-04-93 653798 (Fax)

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