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Agency in Project Screening and Termination Decisions: Why is Good Money Thrown after Bad?

Author

Listed:
  • Chong-en Bai

    (Boston College)

  • Yijang Wang

    (University of Minnesota)

Abstract

We construct an agency model in which the planner (agent) makes project starting and termination decisions on behalf of the state (principal) to reflect the practice of socialist economies. The model shows that asymmetric information between the state and the planner regarding the quality of projects started leads to the persistence of unprofitable projects in most cases. Since in the model it is assumed that the state's objective is to maximize economic profit and the state has full power to dictate and enforce the optimal contract, the finding of the model has the implication that hardening budget constraints in socialist economies is difficult even under an "ideal" setting when these economies are free of social considerations and political frictions.

Suggested Citation

  • Chong-en Bai & Yijang Wang, 1997. "Agency in Project Screening and Termination Decisions: Why is Good Money Thrown after Bad?," Boston College Working Papers in Economics 347., Boston College Department of Economics.
    • Handle: RePEc:boc:bocoec:347
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    Cited by:

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    2. Schaffer, Mark E., 1998. "Do Firms in Transition Economies Have Soft Budget Constraints? A Reconsideration of Concepts and Evidence," Journal of Comparative Economics, Elsevier, vol. 26(1), pages 80-103, March.
    3. J. Kornai & E. Maskin & G. Roland, 2004. "Understanding the Soft Budget Constraint," Voprosy Ekonomiki, NP Voprosy Ekonomiki, issue 11.

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    More about this item

    Keywords

    Soft budget; agency; project screening and termination;
    All these keywords.

    JEL classification:

    • P51 - Political Economy and Comparative Economic Systems - - Comparative Economic Systems - - - Comparative Analysis of Economic Systems
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design

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