The Simple Economics of White Elephants

• Authors: Gerard Llobet and Juan-José Ganuza.
• BSE Working Paper: 110607 | December 19
• Keywords: information acquisition , concession contracts , flexible-term concessions
• JEL codes: D82, D86, H21, L51
• information acquisition
• concession contracts
• flexible-term concessions

This paper shows that the concession model discourages firms from acquiring information about the future profitability of a project. Uninformed contractors carry out good and bad projects because they are profitable in expected terms even though it would have been optimal to invest in screening them out according to their value. White elephants are identified as avoidable negative net present-value projects that are nevertheless undertaken. Institutional arrangements that limit the losses that firms can bear exacerbate this distortion. We characterize the optimal concession contract, which fosters the acquisition of information and achieves the first best by conditioning the duration of the concession to the realization of the demand and includes payments for not carrying out some projects.