The effectiveness of the Spanish urban transport contracts in terms of incentives

Abstract

We consider a principal–agent model in which the regulator faces a moral hazard problem as he cannot observe the effort exerted by public transit operators. In this context, we analyse the effectiveness of the different urban transport contracts signed by the Spanish Central Government since 1990 in terms of incentives. The main result is that none of these contracts provides the appropriate incentives to public transit operators. Thus, we propose a fixed-quantity contract as an alternative financing mechanism. The fixed-quantity contract is a high-powered incentive contract that allows the regulator to perfectly forecast the amount of public funds to be used in the urban transport system. Moreover, the fixed-quantity contract can be adjusted to attain the equilibrium between incentives and optimal allocation of risk.

Acknowledgements

We are grateful for the information given by the Spanish Economic Ministry. We also thank Luis Espadas Moncalvillo and Carlos Ocaña Pérez de Tudela for their helpful comments and suggestions. Financial support from Dirección General de Presupuestos del Ministerio de Economía y Hacienda is gratefully acknowledged. The usual disclaimer applies.

Notes

¹The term passenger-km refers to the amount of kilometres run by passengers.

²If public transit operators exert enough effort, the reduction in costs can be substantial. As an example, we can look at the British case, in which, following the deregulation in the 1980s, public transit operators reduced their costs up to 40% (Heseltine and Silcock, 1990; Jansson and Wallin, 1991; Nash, 1993; Mackie et al., 1995).

³The assumption of quadratic costs for effort is quite common in the Economics of Information literature. Some examples are Arrow and Radner (1979), Gibbons (1998) or Socorro (2007).

⁴There is some empirical evidence supporting the argument that firms with fixed-price contracts (either subsidies or fixed-quantity contracts) have lower operating costs. See, for example, Gagnepain and Ivaldi (2002) for an analysis of the public transit systems in France and Dalen and Gomez-Lobo (1996, 1997) or Jorgensen et al. (1997) for an analysis of the Norwegian case.