Oliver Hart, a Nobel Price winning economist, made the following case against privately founded prisons in an interview from 2017: “There are some things that are difficult to specify [in a contract between a government and a private prison]. One is the quality of the guards. A private company may have incentives to hire cheaper, less trained guards and yet still be within the contract.”
What is this type of contractual problem called? Why does it occur?
I'm struggling with the question above. It is from and old exam in my lecture 'Organization and Management' (consisting mostly of contract theory).
I think the question is either aiming for:
- 'Incompleteness of contracts' since the "quality of guards is hard to specify". Probably because the quality is observable but not verifiable (or specifying the quality would be too costly) OR
- 'Adverse Selection' since the government does not know what kind of cost function a private company would have (for the quality of the guards) prior to signing the contract.
Now that I wrote that I feel like it must be the former just because it makes sense to me.
What do you think? May the contractual problem at hand also be something entirely different?
Thank you in advance, Chris