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Agency in Project Screening and Termination Decisions: Why Is Good Money Thrown After Bad?

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  • Chong-en Bai
  • Yijiang Wang

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. 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 & Yijiang Wang, 1997. "Agency in Project Screening and Termination Decisions: Why Is Good Money Thrown After Bad?," William Davidson Institute Working Papers Series 43, William Davidson Institute at the University of Michigan.
    • Handle: RePEc:wdi:papers:1997-43
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    Cited by:

    1. 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.
    2. Walsh, Patrick Paul & Whelan, Ciara, 2001. "Firm performance and the political economy of corporate governance: survey evidence for Bulgaria, Hungary, Slovakia and Slovenia," Economic Systems, Elsevier, vol. 25(2), pages 85-112, June.
    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

    ex post inefficiency; agency; project screening (and termination); information;
    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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