Hierarchical Contracting in Grant Decisions : Ex-Ante and Ex-Post Evaluation in the Context of the EU Regional Policy

This paper applies incentive theory to the context of the European Union (EU) Regional Policy. The core instruments of the policy are the Structural Funds, capital grants that flow from the European Commission (EC) to Member States and regional authorities to promote investment and growth at local level. The EU grants need a co-payment by the regional government and do not cover in full the investment cost. We model this situation, similar to several other supra- national or federal contexts, as a simple principal-supervisor-agent model of the investment game between a supranational player (the principal), such as the EC, a non (fully) benevolent regional government (the supervisor), and a private firm (the executing agency). We show how the role of providers of additional information, the region (ex-ante) and an evaluator (ex-post) is crucial to reducing the optimal value of the grant and to improving the inefficiencies caused by asymmetric information at the grant decision stage in a federal hierarchy