Incomplete contracts and excludable public goods

We study whether a firm that produces and sells access to an excludable public good should face a self-financing requirement, or, alternatively, receive subsidies that help to cover the cost of public-goods provision. The main result is that the desirability of a self-financing requirement is shaped by an equity-efficiency trade-off: while first-best efficiency is out of reach with such a requirement, its imposition limits the firm's ability of rent extraction. Hence, consumer surplus may be higher if the firm has no access to public funds.

Research Highlights► With a mechanism design approach to public sector pricing problems, the imposition of a self-financing requirement cannot be justified. Instead, public funds should be used to finance public goods provision. ► With an incomplete contracts perspective and a self-interested provider of the public good, consumer surplus may be higher if a self-financing requirement is imposed. The self-financing requirement limits the provider's capability of rent extraction. ► With a commonly known technology, the imposition of a self-financing requirement cannot be justifed.