Adverse Selection and Moral Hazard in Infrastructure Performance-Based Maintenance Contracts

This paper examines adverse selection and moral hazard issues of performance-based infrastructure maintenance contracts signed at different times, and therefore causing payoff externality. These problems are identified by private agent monitoring. Adverse selection and moral hazard cannot be deterred by penalty systems and competitive tendering if maintenance is carried out under a sequence of individual short-term contracts. On the other hand, adverse selection and moral hazard can be effectively deterred by long-term contracts with a single agent internalizing the payoff externality as long as the agent is bound by the contract throughout the contract period. However, the efficiency of a long-term contract is flawed if the agent commits a breach of contract. The paper also investigates the means to deter strategic breaches of the agent.