The Accountability-Innovation Dilemma in

Autocracies

Hongding Zhu, University of Chicago

November 30, 2022

Abstract

Central-local relationships have natural tension in authoritarian politics. From

a governance performance perspective, the central ruler relies on the local agent to

implement policies but is also afraid of the agent’s moral-hazard problem. Central-

ization efforts, such as harsher punishment for policy failure, improve accountability

but inhibit local innovation because innovation is risky. I define this trade-off as

the Accountability-Innovation Dilemma. Therefore, the principal prefers to com-

mit a harsh punishment when an opportunity for innovation is less likely to occur,

which helps to explain why autocracies tend to recentralize after the economy and

governance become more established. This indicates that beyond political survival,

the performance concern can also shape important autocratic institutions. More-

over, the demanding condition of the first-best outcome in the solution suggests

the bluntness of political incentives within a top-down bureaucratic system in local

governance.

Keywords: Autocracy, central-local relationship; accountability; innovation; pol-

icy implementation.
The Accountability-Innovation Dilemma in Autocracies 1

1 Introduction

Centralization or decentralization? This is a tricky choice for autocrats. From a political

survival perspective, autocrats naturally fear that local agents are powerful enough to

overthrow them. In ancient China, it was a common aspiration of the emperors of the

Han, Tang, Ming, and Qing dynasties to take power back from vassal kings or local

warlords. However, no ruler can govern independently. Rulers also have many reasons to

delegate to their local agents. Autocrats may need local leaders to repress, as Putin has

done by granting Kadyrov significant power to rule Chechnya; Decentralization of power

may itself be a necessary concession for rulers to retain their throne since the rulers’ can

make political promises more credible by formally constraining their power Acemoglu and

Robinson (2001); Myerson (2008). For instance, Kazakhstan’s president Mikhail Tokayev

consolidated his power after the political instability in January 2020 but still chose to

strengthen the powers of the local parliaments.

Existing literature has discussed power-sharing and Principal-agent problems in the

general context from the perspective of political survival. For personalist regimes, Egorov

and Sonin (2011) argued that dictators fill their ruling coalition with loyal but incompe-

tent associates to avoid being betrayed by competent agents. In contrast, McMahon and

Slantchev (2015) argued that autocrats would rather appoint competent generals and

use the material incentive to control them. Dragu and Przeworski (2019) also discussed

how autocrats curb the tendency of their repressive agents to raise political threats by

controlling monetary transfer. A dictator will also try to maintain a small winning coali-

tion and seize control of money (De Mesquita et al., 2005). It is also feasible to analyze

the central-local tension under the political survival context. For example, Tolstrup and

Souleimanov (2022) inherited the framework of the Loyalty-Competence trade-off and

2 Hongding Zhu

modeled the power tension between local leaders and the central ruler, taking Kadyrov

and Putin as an example.

However, previous literature could be enriched from two aspects. First, it focuses

solely on political survival, the life-and-death power struggle, but ignores other vital

incentives of autocrats. Second, it does not capture the difference between the central-

local power relationship and the general principal-agent problem.

Autocrats are motivated not only by power struggles in the palace but also by eco-

nomic performance and local governance. It has always been a fundamental goal of

authoritarian regimes to consolidate their rule by providing economic development and

public goods. Wintrobe (1990, 2000) pointed out that authoritarian regimes will pro-

vide public goods to the masses, the so-called ”pigsty project,” to buy loyalty. Output

legitimacy and developmentalism ideology are considered important ruling pillars of au-

thoritarian regimes. We can also infer by observing the propaganda of authoritarian

countries themselves, such as Nazi Germany’s propaganda of highways (Voigtländer and

Voth, 2014) and the Assad regime’s emphasis on its ability to bring peace and order to

people (Wedeen, 2015). In addition, after entering the 21st century, the primary ruling

devices of authoritarian governments have also shifted. Instead of focusing on large-scale

repression, more emphasis has been placed on cooptation and information manipulation

(Svolik, 2012), which emphasizes the importance of economic performance. Especially

for relatively institutionalized authoritarian regimes such as China (Holbig and Gilley,

2010; Zhu, 2011) and Singapore (Wong and Huang, 2010), economic performance and

governance performance have always been the foundation of their country.

From the perspective of economy and governance, as discussed above, autocrats also

need to balance centralization and decentralization. Local agents have moral-hazard

The Accountability-Innovation Dilemma in Autocracies 3

problems, so they may use their autonomy to perform acts harmful to their principals.

For example, the ideal points of an expert may be far away from that of a politician,

causing the politician to withdraw the delegation Holmstrom (1980). Agents may also

use their power in initiation and approval to execute projects that are in their interests,

but harmful to the principal Baker et al. (1999). The last emperor of the Ming Dynasty,

Chongzhen, ended up hanging himself from the Old-Crooked-Neck tree on Mount Mei

after his army had been defeated by the Qing Dynasty because the local nobles refused to

provide enough tax revenue to feed the army. Moreover, just a few years after Chongzhen’s

death, the Qing Dynasty also faced the principal-agent dilemma of local leaders. However,

the central government also strongly needs to grant administrative autonomy from a

governance perspective, as many classics pointed out. In ancient China, the tendency to

strengthen top-down control was paralleled by the emperor’s high reliance on local leaders

at the county and even provincial levels to provide public goods, such as infrastructure

and disaster relief. The fiscal decentralization reforms initiated by the Communist Party

of China in the 1980s were also a corrective to the rigid and inefficient Leninist vertical

governance system, resulting in the rise of ”local corporatism” Oi (1992).

Meanwhile, the relationships between the central and local governments are also dif-

ferent from the principal-agent problem in the general sense. The power arrangement of

the central and local governments is relatively stable over time. We cannot imagine the

central ruler kicking the local governments aside and governing on his own like a legislator

takes power back from the experts. Therefore, the central-local power dynamics are not

only reflected in the formal and large-scale redistribution of decision-making power, but

in contrast, some seemingly technical issues, such as changing the criteria and intensity of

bureaucratic rewards and penalties, actually contain information about the restructuring
4 Hongding Zhu

of central-local power. For example, when the central government imposes more severe

penalties on local governments for governance failures, it limits local governments’ dis-

cretion, forcing them to adopt the logic of avoiding responsibility and making decisions

more prudently.

I, therefore, represent the degree of centralization by starting with the intensity with

which the central government punishes local bureaucrats. I set up an agency model to

discuss how an autocrat concerned with governance performance would balance central-

ization and decentralization. In my model, the central government as the principal needs

to rely on the productivity of the local government to implement a policy with a broad

meaning, such as economic development or governance, and the local agent can choose

either the safe or the innovative way of implementation. Safe policy implementation does

not fail but consumes more resources; Successful policy innovation will improve gover-

nance efficiency, but the agent will be punished once he fails. For the principal, the

punishment is hence a double-edged sword–more lenient punishment encourages more

local innovation, but it also leads to more governance failures due to more reckless risk-

taking by local agents, worsening local accountability, while severer punishment has the

opposite effect.

I define and formalize this trade-off as the “Accountability-Innovation Dilemma”.

Scholars agree that the pursuit of political accountability may face some trade-offs. If

the re-election threshold is too harsh, it may cause the agent to adopt a myopic strategy

that exerts little effort (Gehlbach, 2021), tightening restrictions on election rigging in

a competitive authoritarian regime may improve accountability but at the expense of

increasing the probability of conflict (Luo and Rozenas, 2018), and constraining the

incumbency advantage to improve accountability may increase the risk of democratic

The Accountability-Innovation Dilemma in Autocracies 5

backsliding (Luo and Przeworski, 2019). In formal literature, no model yet discuss the

trade-off between accountability and innovation.

In the solution, there exists a medium optimal intensity of punishment that avoids

accountability costs and insufficient innovation costs. In an incomplete information envi-

ronment in the extension model, since the local agent has an adverse selection problem,

the principal must also offer a medium optimal promotion incentive to encourage the

agent to report truthfully when innovative opportunities arise. Thus, the principal can

only ensure her first-best payoff by offering the optimal punishment and reward. Such

a perfect design of bureaucratic incentive is difficult to achieve in reality, implying the

bluntness of top-down bureaucracy by showing its tendency to distort the agent’s incen-

tive. This complements other research Myerson (2021) on the necessity to establish a

decentralized public goods provision method for which local people can directly hold the

agent accountable.

When the optimal punishment is not feasible, the choice between ”being harsh or

merciful” depends on the probability that an innovation opportunity occurs. In an en-

vironment with abundant innovation opportunities, the principal tends to bear the ac-

countability cost in order to enjoy the efficiency advantage brought by local innovation;

otherwise, the principal will choose to punish the agent more severely to reduce gover-

nance failure. This prediction provides an alternative approach, concerns of governance

performance, to reconsider the central-local tension in autocracies. The results indicate

that, at least for bureaucratic control, performance concerns can shape important au-

thoritarian institutions–the abundance of opportunities for policy innovation affects how

leniently autocrats treat their local agents. This may explain why some autocracies give

greater autonomy to local governments during the early period of rapid economic de-
6 Hongding Zhu

velopment and recentralize power when economic and governance systems become more

established. I use China before and after 2012 as a supportive case of such an explanation.

2 The Model

I begin by showing the technical linkage of my model to other agency models. The

decision process in/between organizations involves four steps: initiation, ratification, im-

plementation, and monitoring(Fama and Jensen, 1983). The divergent allocation of the

four decision rights between the principal and the agent describes a variety of institutional

arrangements. It induces rich theoretical interests, but all involve the pursuit of an ideal

principal-agent relationship in which the principal can effectively induce the productiv-

ity of the agent to achieve a better payoff. For example, Baker et al. (1999); Aghion

and Tirole (1997) discuss the motivation and feasibility of delegating the initiation and

ratification of projects; classic agency models (Eisenhardt, 1989) in light of the latter

two steps focus on moral hazard (Pauly, 1968; Holmstrom, 1982) or adverse selection

(Mirrlees, 1986; Myerson, 1981) of the agent and the qualities of different hierarchical

structures when there are multiple agents (Melumad et al., 1995; Mookherjee, 2006). I

focus on the last two steps—implementation and monitoring. In a bureaucracy, it is com-

mon that the separation of policy-making and implementation makes the principal rely

on result-oriented assessment to monitor and give incentives to the agent. At the same

time, the latter has discretion in the implementation process (Gailmard, 2002), which

causes accountability issues.

There are two main differences between my model and classical agency models. First,

I assume the principal can only use crude instruments, such as punishment or promotion,

instead of monetary transfer. This setup ensures that the ideal type in our model is a
The Accountability-Innovation Dilemma in Autocracies 7

bureaucratic government, not a firm, although, under fiscal federalism, the government

exhibits certain attributes of a firm (Oi, 1992). Therefore, I am able to focus my analysis

on political incentives based on personnel management power.

Second, I assume that the principal also internalizes the spending of the agent. Such a

setting is also due to the substantive difference between the relationship of contractors in

the market and the relationship between different tiers of government. For the latter, even

in a full-scale fiscal federalism setting, the central governments still have the incentive to

save the local fiscal budget. One reason is that the central governments need the local

governments to cope with many tasks simultaneously, therefore, do not want to exhaust

the latter’s money for one single task.

2.1 Setup

The economic environment is a stylized autocratic bureaucracy. The principal cannot

govern independently but relies on a local agent to implement a policy. The policy

outcome is G. She chooses a production target T > 0 and a binary action Z ∈ {0, 1}

where Z = 1 means she punishes the agent by exerting a cost r to his payoff, and r > 0

represents the intensity of punishment. She commits to choosing Z = 1 if G < T , which

means the agent cannot meet the target. The agent has the freedom to choose the method

of implementation E ∈ {0, 1} where E = 0 means the safe method with zero probability

to fail and E = 1 means innovation, which is risky. After choosing the implementation

method, the agent spends x ≥ 0 on production.

In many autocracies, the central ruler does not care about the process and manner

through which her agents carry out the policy but cares more about accomplishing the

goal. China’s “administrative subcontract system” (Zhou, 2016) is a perfect example of

8 Hongding Zhu

such arrangement–Chinese central government issues a policy, and it is then decomposed

into quantifiable and assessable indicators; political principals in each tier of the govern-

ment then iterate this process and subcontract the policy to lower-level agents. In other

autocracies, similar outsourcing systems also exist, sometimes even purer, such as tax

farming.

After the decision of implementation method E and expenditure x, the agent deliver

a policy outcome G such that:

G = (1 − E)P (x) + E(1 − h)kP (x) (1)

where P (x) is a production function strictly concave and P (0) = 0, P ′ (0) = +∞. h ∈

(0, 1) is a probability that the policy fails due to innovation risk. Clearly, G = 0 when the

policy fails. The “failure” here refers to any bad outcome the principal dislikes, which

varies in different regimes. For instance, it could be that the policy turns out to be a

waste of money, delivering no production, or its implementation seriously violates human

rights and causes unexpected civil protests.

k is the efficiency advantage of the innovative policy, shall it be successful, compared

with the safe method. I assume k > 1 to focus on the non-trivial situation where inno-

vation is not obviously inferior to the safe method. k as a random variable complies to a

generic distribution F with the probability density function f .

The agent’s payoff is denoted as:

U = −Zr − x (2)
The Accountability-Innovation Dilemma in Autocracies 9

The principal’s payoff is denoted as:

V = αG − x (3)

where α > 0 means how important the policy is compared with money.

I first discuss the setup with complete information as the baseline to show the main

implications of this article and then discuss the situation in which the principal cannot

observe k as the extension. The sequence of the game in the baseline is as follows:

1. Nature decides the relative efficiency k of innovation according to the distribution

F.

2. the principal observes k, h, chooses a production target T ≥ 0 for the agent, and

commit to choose Z = 1 if G < T ;

3. the agent observes k, h, chooses E ∈ {0, 1}, decides to spend x ≥ 0 on the policy;

4. the policy outcome G is realized and the agent is punished Z = 1 if and only if

G < T;

5. the payoffs are realized.

The equilibrium concept used in the baseline is Subgame Perfect Nash Equilibrium

(SPNE). I ignore Z in the equilibrium because it is mechanical. The action Z is a binary

function simply decided by G and T .

Definition 1 (Equilibrium Concept of the Baseline) An equilibrium consist of T ∗ ∈

R+ , E ∗ : R+ → {0, 1}, and x∗ : R+ → [0, +∞] such that given E ∗ and x∗ , T ∗ maxi-

mize the payoff of the principal; for each T , E ∗ (T, Z) and x∗ (T, Z) constitute a Subgame

Perfect Nash Equilibrium.

10 Hongding Zhu

2.2 Strategy of the Agent

Using backward induction, given T , the agent chooses between three implementation

schemes. First, he can choose no implementation, denoted as aN = {xN = 0}. When

the agent does not exert any effort, E is trivial, and he is sure to be punished. Now his

payoff is UN = −r.

Second, he can choose the safe method of implementation and exert a non-trivial

effort, denoted as aS = {E = 0, xS = P −1 (T )}. Clearly, he will spend the exact amount

of money that makes G = P (x) = T . Any more investment is a waste of money and any

less investment cannot help him meet the target and he would rather choose aN to save

more money. His payoff is accordingly US = −P −1 (T ).

Third, he can be brave and choose to innovate, denoted as aR = {E = 1, xR =

P −1 ( Tk )}1 . Similarly, he will spend the exact amount of money that makes kP (x) = T .

With probability 1 − h he escapes the punishment, and with probability h he is punished.

His payoff is accordingly US = −hr − P −1 ( Tk ).

For convenience, I assume the agent prefers aS to aR to aN whenever the former weakly

dominates the latter. The condition that the agent does not choose aN is either US ≥ UN

or UR ≥ UN . US ≥ UN solves T ≤ P (r) and UR ≥ UN solves T ≤ (1 − h)kP ((1 − h)r).

So we have the first threshold T so that the agent chooses x = 0 if and only if T > T :

T = max{P (r), (1 − h)kP ((1 − h)r)} (4)

The condition that the agent is willing to innovate is UR > US , which solves T ≥ T̃ ,

where T̃ (k, h, r) is a threshold increasing in k and decreasing in h, r. The existence and

uniqueness of T̃ is proved in the appendix. The feasibility of T̃ requires T̃ < T , which

1
I choose the letter “R” as the subscript because innovation is risky
The Accountability-Innovation Dilemma in Autocracies 11

1
P ( 1−h )
solves k > 1−h
. The agent’s calculation of payoff among the three implementation

schemes leads us to Lemma 1, which describes his behavior ai (T ) as an SPNE given T .

1
P ( 1−h )
Lemma 1 (Agent’s Choice When He Makes Budget) When k > 1−h
, the agent

chooses aS if T ≤ T̃ , aR if T̃ < T ≤ T , and aN if otherwise. T̃ increases in r, h and

1
P ( 1−h )
decreases in k. When k ≤ 1−h
, the agent chooses aS if T < T and aN if otherwise.

Intuitively, when the policy target is harder to meet due to the concave property of the

production function P (x), the difference of cost between aS and aR :

 
−1 −1 T
xS (T ) − xR (T ) = P (T ) − P (5)
k

is increasing. The incentive of efficiency (saving money) gradually outweighs the concern

of risks. So the agent tends to choose aR when T is larger. The threshold only exists

when the efficiency k of innovation is large enough compared with its risk h, which is
1
P ( 1−h )
equal to the condition T̃ < T that solves k > 1−h
. And when T > T , both aS and aR

are too costly for the agent, so he simply shirks.

Figure 1: The agent’s choice of implementation method.

12 Hongding Zhu

2.3 Strategy of the Principal

By picking different T > 0, the principal chooses between three payoff functions. When

the agent shirks and chooses aN , the principal’s payoff is denoted as VN = 0; when the

agent plays safe and chooses aS , denoted as VS = αP (xS ) − xS ; and when the agent takes

the risk and chooses aR , denoted as VR = α(1 − h)kP (xR ) − xR .



VS = αP (xS ) − xS T ∈ (0, T̃ ]







V (T ) = VR = α(1 − h)kP (xR ) − xR T ∈ (T̃ , T ] (6)






VN = 0
 T >T

We always have interior solutions to ensure VS > 0 and VR > 0, so VN is never optimal

for the principal. The critical comparison is thus between VS and VN .

Though xS (T ) and xR (T ) are different functions of T , one easier way for the principal

to ponder over the two implementation schemes is changing T to ensure xS = XR , so she

1
can compare the function α(1 − h)kP (x) − x and αP (x) − x. Clearly, when k ≥ 1−h
, VR

weakly dominates VS no matter x. Intuitively, when the relative efficiency k of innovation

is large enough compared with its risk h, it is favorable for the principal to innovate. We

first discuss the global property of VS and VR , without considering the constraint of T .

Denote the first-order derivative of P (x) as p′ , and we solve the optimal T for VS and VR :

  
′−1 1
T̂S = P p (7)
α
  
′−1 1
T̂R = kP p (8)
α(1 − h)k

I further assume α is smaller than some α̃ so that both T̂S , T̂R ≤ T . This assumption helps

to focus on the interesting situation where T̂i are interior, otherwise it degenerates to T
The Accountability-Innovation Dilemma in Autocracies 13

1
1 P ( 1−h )
when either k ≥ 1−h
or k ≤ 1−h
. In this degenerated case, the principal completely

exhausts the agent’s productivity. Substantively, such an extreme case implies that one

single policy is so important that the cost is negligible, and the principal pushes the

agent to the edge of shirking (any more workload will make the agent strike), which is

not common in reality.

To briefly sort out our progress, we have derived the two critical thresholds of k.
1
P ( 1−h )
First, the agent only chooses aR for some large T when k > 1−h
. Second, the principal
1
1 1 P ( 1−h )
prefers VR (T̂R ) to VS (T̂S ) when k ≥ 1−h
. When 1−h
> 1−h
, the discussion will be

1


more interesting, and it requires the condition P 1−h
< 1, which means that the risk is

1


relatively small. Otherwise, if P 1−h
≥ 1, the main result of the following analysis still

remains, but for some k, the situation degenerates. So I only discuss the situation when

1


P 1−h
> 1 and leave the discussion when otherwise in the appendix.

Now take the constraint of T into account. According to Lemma 1, VS (T ) is only

feasible on (0, T̃ ] and VR (T ) is only feasible on (T̃ , T ]. Since T̃ increases in r, given

k, h, under some r small (large) enough, VS (T̂S ) (VR (T̂R )) is not feasible because T̂S > T̃

(T̂R < T̃ ). I define the first-best outcome for the principal as when max{VR (T̂R ), VS (T̂S )}

(the globally optimal payoff) is feasible:

Definition 2 (First-best Outcome) Given k, h, r, a first-best outcome for the princi-

pal is when V = max{VR (T̂R ), VS (T̂S )} in the equilibrium.

If any optimal r that ensures the first-best outcome of the principal exists, it must

1
be medium so as assure when k < 1−h
, r is not too small so that T̂S ∈ (0, T̃ ]; when

1
k ≥ 1−h
, r is not too large so that T̂R ∈ (T̃ , T ]. Under optimal r, the agent’s choice

of implementation method is always aligned with the preference of the principal. The

intuition naturally leads to Proposition 1:

14 Hongding Zhu

Proposition 1 (Feasibility of First-Best with Complete Information) When the

principal observes k, the first-best outcome for the principal is feasible if and only if

r̂S = T̃ −1 P p′−1 1
≤ r ≤ T̃ −1 1
p′−1 1


 


α 1−h
P α
= r̂R .

When the parameter r is too large, r > r̂R , the first-best outcome is not feasible

1
for the principal when k ≥ 1−h
. The agent is unwilling to innovate under T = T̂R (k)

because the punishment for failure is too harsh. The principal now has two options. First,

she can pick the nearest T larger than T̂R , which is T̃ , and get the payoff VR (T̃ ). By

setting a heavier workload, she can force the agent to innovate (to save money), but this

also deviates from the optimal production of innovation. Second, she can abandon the

innovation opportunity and instead choose T = T̂S to get VS (T̂S ). Her choice between

the two “plan-Bs” depends on how large T̃ is, given VR (T ) a decreasing function on

T > T̂R . And T̃ is increasing in r. So when r is larger than some threshold r̃R so that

VR (T̃ ) < VS (T̂S ) the principal abandon the innovation opportunity and would rather

choose to play safe.

Similarly, when r is too small, r > r̂R , the first-best outcome is not feasible for
1
P ( 1−h ) 1 2
the principal when 1−h
≤ k < 1−h
. The principal chooses T = T̃ if and only if

1
r̃S ≤ r < r̂S , otherwise she chooses T = T̂R , even though now k < 1−h
. I now formally

present the equilibrium of the model and leave the proof in the appendix:

Proposition 2 (Equilibrium of The Baseline)

1
P ( 1−h )
1. When k ≤ 1−h
, T ∗ = T̂S , a∗ = aS , and the outcome is first-best.
1
P ( 1−h ) 1
2. When 1−h
<k< 1−h
,

T ∗ = T̂S , a∗ = aS if r ≥ r̂S , which is first-best;

T ∗ = T̃ , a∗ = aS if r ∈ [r̃S , r̂S ), which is not first-best;

2 P ( 1−h
1
)
Recall Lemma 1, when k < 1−h , the agent always plays safe because innovation is too inefficient.
The Accountability-Innovation Dilemma in Autocracies 15

T ∗ = T̂R , a∗ = aR if r ∈ (0, r̃S ), which is not first best.

r ≥ T̃ −1 P p′−1 1



α

1
3. When k ≥ 1−h
,

T ∗ = T̂R , a∗ = aR if r ≤ r̂R , which is first-best;

T ∗ = T̃ , a∗ = aR if r ∈ [r̂R , r̃R ), which is not first-best;

T ∗ = T̃ , a∗ = aS if r ∈ [r̃R , +∞), which is not first-best.

1
Figure 2: r̂R < r̃R < r, k > 1−h . The first-best outcome is not feasible for the principal
when the optimal innovation is ex-ante better, but the punishment intensity is too large.

1
Figure 3: r̃S < r < r̂S , k < 1−h . The first-best outcome is not feasible for the principal
when the optimal safe implementation is ex-ante better, but the punishment intensity is
too lenient. The optimal policy target and payoff of playing safe are not feasible, but the
largest feasible payoff of playing safe, VS (T̃ ), is still better than innovation.
16 Hongding Zhu

3 The Accountability-Innovation Dilemma

The equilibrium tells a simple story, with the key role played by the intensity of punish-

ment r. Recall Proposition 1, when r is optimal in a medium range, there is no trade-off

between the accountability cost and potential loss of innovation. However, when r is too

large or small, the principal suffers a loss of payoff by the agent’s tendency to “choose the

wrong option” which is inevitable—the agent’s willingness to innovate when the principal

needs innovation is inhibited by too harsh punishment, or he is encouraged by too-lenient

punishment to recklessly innovate when it is not efficient for the principal.

In a previous analysis, I take k as given and discuss the equilibrium outcome of the

game under different r. Now, to formally define the Accountability-Efficiency Dilemma, I

suppose the principal can choose r from some parameter space and discuss the principal’s

payoff given the distribution of k.

When r is optimal, for any k, the principal is able to get max{VS (T̂S ), VR (T̂R (k))}.

Her ex-ante payoff is thus:

1
Z
1−h
Z +∞
Vr∈[r̂S ,r̂R ] = VS (T̂S (k))dF + VR (T̂R (k))dF (9)
1
1 1−h

I define the inefficiency caused by the too-harsh punishment as the “innovation insuffi-

1
ciency.” When r > r̂R , for some k ≥ 1−h
the principal cannot get VR (T̂R (k)), but instead

get max{VR (T̃ (k; r)), VS (T̂S )}. The agent’s willingness to innovate under T = T̂R (k) re-

quires T̃ (k; r) < T̂R (k), which solves k > k̂R (r), where k̂R (r) is a threshold of k that

increases in r. Intuitively, when punishment is too harsh, the agent is only willing to

innovate when it brings him a huge efficiency advantage and thus saves much money,

outweighing the risk of punishment.

The Accountability-Innovation Dilemma in Autocracies 17

In contrast, I define the inefficiency caused by the too-lenient punishment as the

1
“accountability cost.” Similarly, when r < r̂S , for some k < 1−h
the principal cannot get

VS (T̂S ), but instead get max{VS (T̃ (k; r)), VR (T̂R )}. The agent is only willing to play safe

under T = T̂S when T̃ (k; r) ≥ T̂S , which solves k < k̂S (rL ) where k̂S (rL ) is a threshold

of k that increases in r. Intuitively, when punishment is too lenient, the agent’s reckless

innovation causes unnecessary risks of policy failure, and he only plays safe when the

successful innovation brings him little efficiency advantage.

Proposition 3 (The Accountability-Innovation Dilemma) When r > r̂R , the prin-

1
cipal’s payoff is not first-best when k ∈ [ 1−h , k̂R (r)] (cost of innovation insufficiency);

1
when r < r̂S , the principal’s payoff is not first-best when k ∈ [k̂S (rL ), 1−h ] (cost of ac-

countability).

The proof of Proposition 3 is in the appendix. I then quantify the two costs by writing

down the ex-ante payoff of the principal:

Z Z 1
 k̂S (rL ) 1−h
Z +∞
VS (T̂S (k))dF + V1 dF + VR (T̂R (k))dF r ∈ (0, r̂S )



1



 1 k̂ S (r L ) 1−h

Z 1 Z +∞
1−h

V = VS (T̂S (k))dF + VR (T̂R (k))dF r ∈ [r̂S , r̂R ] (10)
1

 1 1−h


 Z 1 Z k̂R (r) Z +∞
1−h


VS (T̂S (k))dF + V2 dF + VR (T̂R (k))dF r ∈ (r̂R , +∞)



1

1 1−h
k̂R (r)

in which V1 refers to non-first-best payoff with accountability cost and V2 refers to non-

first-best payoff with innovation insufficiency. The cost of accountability C1 and innova-
18 Hongding Zhu

tion insufficiency C2 is accordingly:

Z 1
1−h
C1 = VS (T̂S (k)) − V1 dF (11)
k̂S (rL )
Z k̂R (r)
C2 = VR (T̂R (k)) − V2 dF (12)
1
1−h

Clearly, given that k̂i (r) increases in r, C1 decreases in r and C2 increases in r. Any

planner who can design r faces this trade-off between the two costs when no optimal r

is available in the parameter space. Suppose the principal can choose a discrete set of

r from a coarse parameter space. Denote {rL , rH } as a pair of available r closest to the

range of optimal r, such that rL < r̂S < r̂R < rH . When the principal chooses rL (rH ),

she suffers the cost C1 (C2 ), so her calculation is based on comparing the two costs.

1 1
The probability that k appears in [k̂S (rL ), 1−h ] and [ 1−h , k̂R (rH )] is the critical fac-

tor that determines which cost is higher. An extreme case is when the probability

1
F (k̂R (rH )) − F ( 1−h ) arbitrarily close to 0, the cost of innovation insufficiency is close

to 0. Hence, the principal only worries about reducing the accountability cost, and she

chooses the harsh punishment rH . The intuition is that when the opportunity for inno-

vation is rarer, the inefficiency caused by inhibited innovation under a harsh punishment

is smaller than the accountability cost caused by reckless innovation under a lenient pun-

ishment. Similarly, when the opportunity for innovation is rich, the accountability cost

is higher than the cost of innovation insufficiency.

Proposition 4 (Choice of Punishment Intensity) When the principal can decide r,

she chooses among the optimal set of r whenever available. If not available, the principal

1
chooses the harsh punishment rH when F (k̂R (rH ))−F ( 1−h ) is sufficiently small compared

1
with F (k̂S (rL )) − F ( 1−h ), and she chooses the lenient punishment rL if otherwise.
The Accountability-Innovation Dilemma in Autocracies 19

4 Extension: Incomplete Information

Consider an alternative setup where the principal cannot observe the realization of k.

For brevity, I assume k ∈ {kL , kH } such that:

1
kL < < kH (13)
1−h

and Pr(k = kH ) = q ∈ (0, 1). The principal replies to a message from the agent, m,

to know if there is any good opportunity for innovation. It is natural to think m ∈

{L, H}. The feasibility of the first-best outcome requires the agent to stick to strategies

with truthful report m = k, which is an extra requirement compared with the complete

information setup. I assume r is optimal in this extension to focus on the effect of

incomplete information on the outcome.

First, look at the possible strategies of the players in a strategic form:

Table 1: Payoffs without Reward for Innovation

m=k m=L m=H m = ¬k
∗ ∗ ∗ ∗ ∗ ∗
ignore m V ,U V ,U V ,U V ∗, U ∗
believe m Vtrue , Utrue VfLake , UfLake VfHake , UfHake VfLH LH
ake , Uf ake

When the principal ignores m, she plans based on the prior q, and the two players

get respectively V ∗ and U ∗ . Clearly, V ∗ is not the first-best outcome for the principal.

Instead, only when the agent report m = k and the principal plans based on m can she

get the first-best outcome, denoted as Vtrue .

When the agent report m = k (truthfully), his payoff is:

Utrue = −(1 − q)xS (T̂S ) − q[xR (T̂R ) + hr] (14)

20 Hongding Zhu

which is less than the payoff when he always report m = L:

UfLake = −(1 − q)xS (T̂S ) − q min{xR (T̂S ) + hr, xS (T̂S )} (15)

The intuition is that reporting any m = H makes the principal think there is a good

opportunity for innovation and thus choosing a high production target T̂R due to the

efficiency advantage of innovation. To save some effort, the agent has the incentive

always to report a lower type, deviating from m = k to m = L, given that the principals

believe the message. To make it incentive compatible for the agent to report m = k,

naturally, the principal must reward any m = H with an extra political incentive w > 0

to compensate the agent. w could be any political reward, but it is the most intuitive if

we consider it a promotion. The payoffs with the political reward w for innovation are:

Table 2: Payoffs with Reward for Innovation

m=k m=L m=H m = ¬k
ignore m V ∗, U ∗ V ∗, U ∗ V ∗, U ∗ V ∗, U ∗
believe m Vtrue , Utrue + qw VfLake , UfLake VfHake , UfHake + w VfLH LH
ake , Uf ake + qw

w must be large enough so that Utrue + qw ≥ UfLake so the agent is willing to report

m = H; also not too large to ensure Utrue + qw ≥ UfHake + w so the agent will not report

m = H even when k = kL 3 . The two conditions solve:

UfLake − Utrue Utrue − UfHake

≤w≤ (16)
q 1−q

which leads us to the next proposition:

Proposition 5 (Feasibility of First-Best with Incomplete Information) When the

principal does not observe k, the first-best outcome for the principal is feasible if and only
3
We do not need to worry about the strategy m = ¬k because it is inferior to either m = L or m = H
The Accountability-Innovation Dilemma in Autocracies 21

if both

1) r̂S = T̃ −1 P p′−1 1
≤ r ≤ T̃ −1 1
p′−1 1


 


α 1−h
P α
= r̂R .
UfLake −Utrue Utrue −UfHake
2) q
≤w≤ 1−q

The proof of Proposition 5 is well-embodied in the inferring above.

5 Discussion

5.1 The Bluntness of Bureaucratic Incentives

Propositions 1,2,3 and 5 together characterize the bluntness of bureaucratic instruments,

punishment, and promotion, by showing the vulnerability of the first-best outcome in

policy implementation. Conditions to ensure the first-best payoff for the principal are

very demanding in the real world, constrained by the institutional environment, which is

why it is common to see bureaucratic failures and incentive distortions empirically.

The principal must be able to commit to a punishment intensity r, and the optimal set

[r̂S , r̂R ] must be available in the parameter space. However, first, the principal may not

be able to set r. In a multi-level bureaucratic system, r is possibly the choice made by the

higher-level principals. Additionally, in the long-term interaction between the principal

and the agent, r is constrained by other contracts and institutions and is thus stable

in a specific period, making the principal hard to adjust. Second, the parameter space

of available r could be coarse. In specific policy fields, ideological fences undermine the

credibility of small r, while nepotism (He, 2000) and collisions (Zhou, 2016) undermine

the credibility of large r.

The principal must also be able to reward innovative agents with political incentives,

such as promotion. However, first, the principal may not be able to grant such a reward.
22 Hongding Zhu

Take China as an example. The power of promotion is centralized in the Organization

Department (zuzhibu) of the Party Committee one level higher, which limits the situations

where promotion incentive is an available instrument. Second, even if the principal can

commit to the reward, the parameter space could also be coarse. In China, the criteria

for promotion in CCP are intentionally kept vague to prevent the opportunistic behavior

of the agent, so the principal cannot commit to promoting an agent with certainty, while

nepotism and favoritism further undermine the credibility of promotion reward. Also,

promotion as an instrument is not free. The political selection (meritocracy) value of

promotion indicates that the principal not only wants to induce the productivity of agents

for particular policies but also to promote more capable agents—there are only limited

seats for promotion. Though such an incentive is not discussed in the article, it is not

negligible in the real world.

The discussion above supplements existing literature on the limitation of the central-

ized, top-down system in public goods provision by showing its inevitability to distort the

agent’s incentive. Myerson (2021) argued that an autocratic bureaucracy frustrates local

governance due to the central leader’s inability to commit to punishing the local agent for

governance failure when the agent delivers her benefits. However, my model implies that

even when the central leader’s preference is perfectly aligned with local people (suppose

they share the same utility function), the policy outcome can still be distorted by the

demanding requirements for perfect bureaucratic control. Fortmann et al. (1986) and

Ostrom (1990) emphasized the importance of locally accountable usage of the budget

and organization leadership. In my model, if such institutions exist so that the people

can set the upper bound of expenditure after observing the realization of k, then the

agent cannot increase his payoff by wasting money to implement the safe method when
The Accountability-Innovation Dilemma in Autocracies 23

the innovative method is ex-ante better for local people.

5.2 Recentralization of Autocracies

Proposition 4 shows the critical factor in the model, the probability that an innovation

opportunity arises, according to which the principal adjusts her choice of punishment

intensity. When there are more innovation opportunities, the principal tends to internalize

the accountability cost in order to enjoy the efficiency edge of more local innovation. In

contrast, when there are scarce opportunities, the accountability cost resulting from the

reckless risk-taking of the agent outweighs the efficiency edge, and the principal hence

chooses a harsher punishment.

This provides an alternative way to explain the central-local power dynamics in autoc-

racies. Previous literature proposed reasons based on political survival or political con-

flicts, as discussed in the introduction. Indeed, to reduce internal conflicts or strengthen

the legitimacy of the central government, the decentralization or centralization strategies

are widely leveraged (Siegle and O’Mahony, 2010; Brancati, 2006). However, it does not

explain the central-local dynamics in full-scale autocracies like China, where no substan-

tial and formal decentralization of state power has been issued. Fiscal federalism, from

an economic point of view, could explain the delegation of financial and administrative

power to local governments in China. However, it cannot account for the recentralization

trend in China after 2012.

The recentralization trend in China is partly an effort to improve local accountability

at the expense of the willingness of local agents to initiate policy experiments. After

Xi Jinping became the leader of CCP in 2012, China initiated a recentralization process,

including strengthening digital screening (Gao and Tan, 2020), anti-corruption, personnel
24 Hongding Zhu

rearrangement, realignment of central-local decision-making power, and increased pun-

ishment for local policy failure and disobedience. One critical goal of this effort is to

curb “localism” (Bulman and Jaros, 2021), which points directly to the accountability

problem of local governance. Unorthodox, sometimes illegal, and risky, local policy in-

novation has played a significant role in China’s economic miracle but also caused severe

local accountability problems (Heilmann, 2018). In the famous piece, O’Brien and Li

(1999) discovered the selective implementation behavior of Chinese local governments

in rural areas, discussing how the difficulty of policy outcome evaluation, fiscal incen-

tives, and the transition of the cadre assessment system distort the implementation–it

was common that harmful policies were executed with great efforts while policies wel-

comed by the people were ignored. The official rhetoric of the CCP on policy innovation

after 2012 claimed that “policy innovation should be constrained by the rule of law”, and

”disorderly action,” a charge against local cadres for risky and abusive policy innovation,

also emerged after the recentralization process in 2012 4 . Thus, the recentralization ef-

fort is partly based on the “urgent need” of China to reform, which requires a strong

central government (Gao and Teets, 2020) to overcome the fragmented political system

(Lieberthal and Lampton, 2018; Mertha, 2009). However, as predicted by the intuition

of the Accountability-Innovation dilemma, the local state agents are halting policy ex-

perimentation (Heilmann, 2018) under harsher punishment.

6 Conclusion

I set up an agency model to discuss an autocrat’s decision of centralization or decentral-

ization based on the concern of local governance performance, using the intensity of bu-
4
http://www.xinhuanet.com/politics/2016-01/15/c 128632676.htm
The Accountability-Innovation Dilemma in Autocracies 25

reaucratic punishment as an entry point. I formalize the trade-off in such decision-making

as the Accountability-Innovation Dilemma. The arrangement of top-down punishment

intensity contains information on the central ruler’s effort to reduce local discretion in

executing risky policies. By making policy failures more costly, harsher top-down punish-

ment helps to reduce unnecessary risky policies and improve the accountability of local

governance. However, it can also inhibit necessary local innovation when opportunities

arise.

The conditions are strict for the principal to avoid such a dilemma and ensure the

first-best policy outcome, which requires both the punishment and reward for the agent

to be optimal, within a medium range. In reality, the feasibility of such conditions

is hindered by multiple political factors, pointing out the limitations of the top-down

bureaucratic method in local public good provision. Institutions that empower people in

budget-making after observing the policy innovation opportunity facilitate the prevention

of the moral-hazard situation in which the agent holds back on necessary innovation and

wastes extra money.

When optimal punishment is not feasible for the principal, she trades off between

the two costs: the insufficient innovation caused by a too-harsh punishment or the ac-

countability deterioration caused by reckless local risk-taking. When the probability that

an innovation opportunity occurs is small, the principal prefers to exert harsher punish-

ment for policy failure. This helps explain why autocracies adopt recentralization reforms

aimed at improving local governance accountability after the rapid growth phase and indi-

cates that the incentive of policy output can shape important institutional arrangements

in autocratic central-local relationships.

26 Hongding Zhu

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Appendix

Proof of Lemma 1

1. The Derivation of T . UN ≤ US requires −r ≤ −P −1 (T ), which solves T ≤ P (r);

UN ≤ UR requires −r ≤ −(1 − h)r − P −1 ( Tk ), which solves T ≤ (1 − h)kP ((1 − h)r).

So the upper bound of T that ensures either aS or aR weakly dominates aN is T =

max{P (r), (1 − h)kP ((1 − h)r}.

2. The Derivation of T̃ . To understand the existence of T̃ , construct:

T
Q(T ) = US (T ) − UR (T ) = (1 − h)r + P −1 ( ) − P −1 (T ) (17)
k

and extend the domain of T to {0}. US (0) = −P −1 (0) = 0 and UR (0) = −(1 − h)r −

P −1 (0) < 0, so Q(0) = US (0) − UR (0) > 0. And clearly US (+∞) < UR (+∞), so

Q(+∞) = US (+∞) − UR (+∞) < 0. By the existence theorem of zero point of continuous

function, there must exist some T̃ so that Q(T̃ ) = 0 and accordingly, US (T̃ ) = UR (T̃ ).

The uniqueness of T̃ requires the monotonicity of Q(T ). By the implicit function

theorem, we have:

1
x′S (T ) = (18)
p′ (x S)

1
x′R (T ) = (19)
kp′ (x R)

1 1 1 1 1−k
Q′ (T ) = − < − = <0 (20)
kp′ (x R) p′ (x S) kp′ (x R) p′ (x R) p′ (xR )

So Q(T ) is decreasing in T and the uniqueness of T̃ is proved.

The Accountability-Innovation Dilemma in Autocracies 31

3. The Monotonicity of T . The equation that pins down T̃ is equivalent to:

xS (T ) − xR (T ) + (h − 1)r = 0 (21)

By the implicit function theorem, we have:

dT̃ P (xR )
= ′ <0 (22)
dk 1 − k pp′(x R)
(xS )

dT̃ −(1 − h)kp′ (xR ))

= ′ >0 (23)
dr 1 − k pp′(x R)
(xS )

dT̃ −rkp′ (xR ))

= ′ >0 (24)
dh 1 − k pp′(x R)
(xS )

Proof of Proposition 1

1
P ( 1−h )
Case 1. When k ≤ 1−h
. r does not affect the payoff of the principal because the

first-best outcome under aS is always feasible.

1
P ( 1−h ) 1
Case 2. When 1−h
< k < 1−h
. The principal only worries if r is too small. To
1
P ( 1−h ) 1
ensure the feasibility of the highest possible payoff VS (T̂S ) when 1−h
< k < 1−h
, r

must be larger than a unique r̃S such that:

1
T̃ ≥ T̂S = P (p′−1 ( )) (25)
α

1
Case 3. When k ≥ 1−h
. The principal only worries if r is too large. To ensure the

1
feasibility of the highest possible payoff VR (T̂R ) when k ≥ 1−h
, r must be smaller than a
32 Hongding Zhu

unique r̃R (k) such that T̃ ≤ T̂R . Given T̂R an increasing function of k and k is a random

1
variable, so T̃ ≤ T̂R must be satisfied for the smallest k = 1−h
, which requires:

1 1
T̃ ≤ P (p′−1 ( )) (26)
1−h α

The two equations above together solves:

1 1 1
T̃ −1 [P (p′−1 ( ))] ≤ r ≤ T̃ −1 [ P (p′−1 ( ))] (27)
α 1−h α

Proof of Proposition 2

1
P ( 1−h )
Case 1. When k ≤ 1−h
. T ∗ = T̂S and a∗ = aS (T̂S ). Because now k is also smaller

1
than 1−h
, VS is favored by the principal and for any non-trivial T ≤ T , the agent only

chooses aS . This equilibrium ensures first-best outcome for both players.

1
P ( 1−h ) 1 1
Case 2. When 1−h
<k < 1−h
. The principal prefers aS since k < 1−h
, however,
1
P ( 1−h )
because k > 1−h
, for T > T̃ the agent only chooses aR . So when T̂S > T̃ , which means

that r < r̂S the first-best payoff VS (T̂S ) is not feasible for the principal, and she receives

max{VS (T̃ ), VR (T̂R ).

Now let us compare min{VS (T̃ ) and VR (T̂R ). Due to the single-peak property, VS (T )

increases in T̃ when T̃ < T̂S . T̃ (r) : R+ → R+ is monotonically increasing in r according

to Lemma 1 and VS (T ) : R+ → (0, VS (T̂S )]. So we have VS (T̃ ) as an increasing function

of r whenever T̃ < T̂S :

VS (r) : R+ → (0, VS (T̂S )] (28)

The Accountability-Innovation Dilemma in Autocracies 33

Clearly, there must exists a unique r̃S such that VS (T̃ ) < VR (T̂R ) when r < r̃S . Hence,

when r < r̃S , the principal has to receives the second-best payoff VR (T̂R ); when r̃S < r <

rS , she receives VS (T̃ ), which is also not first-best.

So we have when r ≥ R̂S , T ∗ = T̂S , a∗ = aS (T̂S ), the principal receives the first-best

payoff VS (T̂S ). When r̃S ≤ r < r̂S , T ∗ = T̃ , a∗ = aS (T̃ ), the principal receives the

non-first-best payoff VS (T̃ ). When r < r̃S , T ∗ = T̂R , a∗ = aR , the principal receives the

non-first-best payoff VR (T̂R ).

1
Case 3. When k ≥ 1−h
. Case 3 is a mirroring of Case 2. The principal prefers aR since
1
1 P ( 1−h )
k≥ 1−h
, however, because k > 1−h
, for T ≤ T̃ the agent only chooses aS . So when

T̂R ≤ T̃ , which means that r > r̂R the first-best payoff is not feasible for the principal

and she receives max{VR (T̃ ), VS (T̂S )}.

Similarly, the compare between the two non-first-best payoff depends on a threshold

r̃R . Due to the single-peak property, VR (T ) decreases in T̃ when T̃ ≥ T̂R . Similar to

Case 2 but mirroring, we have VR (T̃ ) as a decreasing (instead of increasing) function of

r whenever T̃ ≥ T̂S :

VR (r) : R+ → (0, VR (T̂R )] (29)

There must exists a unique r̃R such that VR (T̃ ) < VS (T̂S ) when r ≥ r̃R . Hence, when

r ≥ r̃R , the principal has to accept the non-first-best payoff VS (T̂S ); when r̂R ≥< rr̃R ,

the principal receives the non-first-best payoff VR (T̃ ).

So we have when r < r̃R , T ∗ = T̂R , a∗ = aR (T̂R ), the principal receives VR (T̂R ), which

is first-best for the principal; when r̂R ≥ r ≤ r̃R , T ∗ = T̃ , a∗ = aR (T̃ ) (notice that the

agent is indifferent between aS and aR on T̃ ), the principal receives the one-first-best

payoff VR (T̃ ); when r > r̃R , T ∗ = T̂S , a∗ = aS (T̂S , the principal receives the non-first

best payoff VS (T̂S ).

34 Hongding Zhu

Proof of Proposition 3

1
I first prove the cost of innovation insufficiency. When k ≥ 1−h
, the first-best payoff of

the principal is VR (T̂R ). According to Lemma 1, when T = T̂R (k), the agent chooses aR

and deliver the first-best payoff for the principal if and only if T̂R (k) > T̃ (k, r). Denote

this condition as:

ΠR (k) = T̂R (k) − T̃ (k, r) > 0 (30)

1
According to Proposition 1, the condition is satisfied for k > 1−h
if and only if r < r̂R ,

which is to say there must be some ΠR (k) ≤ 0 when r ≥ r̂R . We know that T̂ (k) is

increasing in k and T̃ (k, r) is decreasing in k, so ΠR (k) is an monotonically increasing

function. Accordingly, when r ≥ r̂R , there must be a unique k̂R (r) such that ΠR (k) ≤ 0

1
on [ 1−h , k̂R (r)] and ΠR (k) > 0 if otherwise.

Next, I prove the cost of accountability part of the proposition, which complies to the
1
P ( 1−h ) 1
mirroring logic of the first part. When 1−h
<k < 1−h
, the first-best payoff for the

principal is VS (T̂S ), which requires the agent chooses aS when T = T̂S . Then, according

to Lemma 1, it requires T̂S ≤ T̃ . Denote this condition as:

ΠS (k) = T̂S − T̃ (k, r) < 0 (31)

 1

P ( 1−h ) 1
According to Proposition, the condition is satisfied for any k ∈ 1−h
, 1−h if and only

if r ≥ r̂S , which is to say there must be some ΠS (k) ≥ 0 when r < r̂S . Given T̃ (k, r) a

decreasing function of k, ΠS (k) is increasing in k. Accordingly, when r < r̂S , there must

1
be a unique k̂S (rL ) such that ΠS (k) ≥ 0 on [k̂S (rL ), 1−h ] and ΠR (k) < 0 if otherwise.
The Accountability-Innovation Dilemma in Autocracies 35

Proof of Proposition 4

Without any lose of generality, I provide a more intuitive proof of this proposition assum-

ing that k complies to a uniform distribution F . k ∈ [1, k], where k is an upperbound

1
large enough such that k > 1−h
. The existence of such upperbound is natural because

we cannot imagine a policy innovation that yields infinite payoff for the principal.

Recall the cost of accountability C1 and innovation insufficiency C2 :

Z 1
1−h
C1 = VS (T̂S (k)) − V1 dF (32)
k̂S (rL )
Z k̂R (r)
C2 = VR (T̂R (k)) − V2 dF (33)
1
1−h

   
1 1


We want to prove that C1 > C2 when F k̂R (rH ) −F 1−h = Pr 1−h < k < k̂R (rH )
 
1
is small enough, which is equal to when Pr k̂S (rL ) < k < 1−h is large enough. Denote
   
1 1
Pr k̂S (rL ) < k < 1−h as Γ1 (h) and Pr 1−h < k < k̂R (rH ) as Γ2 (h). Given F a uniform

distribution, we have when r = rH :

1
1−h
− k̂S (rL )
Γ1 (h) = (34)
k−1

and when r = rL :
1
k̂R (rH ) − 1−h
Γ2 (h) = (35)
k−1

where Γ1 (h) is weakly increasing in h and Γ2 (h) is the opposite. Therefore, the proof

of Proposition 4 is equal to prove that C1 > C2 when h > h∗ , where h∗ is a threshold

∈ (0, 1).
36 Hongding Zhu

Notice that when h → 0:

1
Z limh→0 1−h
Z 1
lim C1 = VS (T̂S (k)) − V1 dF = VS (T̂S (k)) − V1 dF = 0 (36)
h→0 limh→0 k̂S (rL ) 1
Z limh→0 k̂R (r)
lim C2 = VR (T̂R (k)) − V2 dF > 0 (37)
h→0 1

and when h → 1:

Z k
lim C1 = VS (T̂S (k)) − V1 dF > 0 (38)
h→1 k̂S (rL )
Z limh→0 k̂R (r) Z k
lim C2 = VR (T̂R (k)) − V2 dF = VR (T̂R (k)) − V2 dF = 0 (39)
h→1 limh→0 1
k
1−h

Denote C1 − C2 as a new function β(h). Due to the monotonicity of C1 (h) and C2 (h),

β(h) is increasing in h. And we have that on h ∈ (0, 1):

lim β(h) < 0 (40)

h→0

lim β(h) > 0 (41)

h→1

So there must be a unique h∗ such that β(h∗ ) = 0.