Monday, April 27, 2009

The Problem of Moral Hazard

A recent article by CNN titled "City bike-sharing picks up speed" discusses the problem of moral hazard. Wikipedia defines moral hazard as "the prospect that a party insulated from risk may behave differently from the way it would behave if it were fully exposed to the risk." Wikipedia goes on to define a specific type of moral hazard which is called a " 'principal-agent problem', where one party, called an agent, acts on behalf of another party, called the principal. The agent usually has more information about his or her actions or intentions than the principal does, because the principal usually cannot perfectly monitor the agent. The agent may have an incentive to act inappropriately (from the viewpoint of the principal) if the interests of the agent and the principal are not aligned." As proven by JCDecaux's recent threats to close stations plagued by theft and vandalism as reported here at The Bike-sharing Blog in February, the bike-sharing industry has proven it is not free of controversy and has the problem of moral hazard.

The CNN article quoted me stating that "[T]he advertising company does not benefit from revenues generated by the system as the jurisdiction does, so the advertising company does not have the same incentive to keep the bikes maintained as the jurisdiction would if it were operating the system. In fact, the better the advertising company has the bikes maintained, the more expensive it would be, and the less profit they would keep from the advertising contract."

Stronger oversight of bike-sharing programs by local governments is needed to ensure the principal knows as much as the agent, as described above. One important step towards this is separating the advertising contract with the bike-sharing contract so true costs can be realized. A better method of provision could be the locality providing a management fee to the operator for the bike-sharing service. This management fee would include staffing, maintenance, distribution, and customer care.

The service provider also should benefit monetarily from the success of the program and conversely be fined for not providing the quality of service to which they agreed to perform. Bike-sharing contracts should have carrots and sticks to encourage not just fair play by the agent, but superior behavior that is appropriate for a modern transit service with high customer interaction and expectations.

image credit: Wall Street Journal

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