Spatial dependence through local yardstick competition: theory and testing

We propose a model of contracting for natural monopolies in which yardstick evaluation of performance can be optimal. Where principals have partially unobservable objective functions and agents are risk averse an externality is generated which can be observed in patterns of spatial dependence. Imposing standard contracting rules on principals can eliminate the externality and spatial dependence. We test this prediction using spatial econometrics on UK data covering a regime shift from independent contracting to compulsory competitive tendering rules.