Optimizing performance-based mechanisms in road management: an agency theory approach

Abstract

This paper develops a model based on the agency theory to analyse road management systems that employ a mechanism of performance indicators to establish the payment for the contractor. The base assumption is the asymmetric information between a principal (Public Authorities) and an agent (contractor) and the risk aversion of the latter. It is assumed that the principal may only measure the agent’s performance indirectly and by means of certain performance indicators that may be verified by the authorities. In this model it is assumed there is a relation between the efforts made by the agent and the performance level measured by the corresponding indicators, although there may be dispersions between both variables that give rise to a certain degree of randomness in the contract. An analysis of the optimal mechanism was made on the basis of this model and in accordance with a series of parameters that characterize the economic environment and the particular conditions of road infrastructure. As a result of the analysis, the incentive mechanism should include a fixed component and a payment according to the obtained performance level. The higher the risk aversion of the agent and the greater the marginal cost of public funds, the lower the impact of this performance-based payment. By way of conclusion, the system of performance indicators should be as broad as possible but should avoid those indicators that encompass greater randomness in their results.