Optimal Mix of Penalties in a Principal-Agent Model under Different Institutional Arrangements

Abstract

This paper uses principal-agent theory to examine the optimal mix of monetary- and resource-based penalties in two institutional settings: a market economy and a centrally planned economy. In a centrally planned economy, an agent's wealth depends mostly on real resources and little on monetary resources; therefore, monetary-based penalties have less penalizing power than do resource-based penalties. Based on this premise, theory generates hypotheses regarding differences in the optimal mix of penalty types between the two economic systems. This paper empirically tests these hypotheses using data from the Czech Republic regarding enforcement responses to water-damaging accidents (such as oil spills).