The Babu and the Boxwallah: Managerial Incentives and Government Intervention in a Developing Economy

In developing economies a firm's strategy is directed more often at the government than at other competing firms. As an initial step towards modeling such interactions this paper considers a situation where a government confronts a monopoly. The latter chooses price and maximizes profit and the former chooses a tax rate and maximizes tax revenue. The government and the monopoly can delegate the final decision-making to, respectively, a bureaucrat and a manager. The incentive equilibrium of the model is characterized. It is shown that this kind of industrial setting is likely to exhibit greater inefficiencies than that which arises in standard models.