Optimal Pricing of Public Franchises With Imperfectly Correlated Demand Shocks

ABSTRACT In a dynamic adverse selection setting with private information about stochastic consumer preferences, we study the pricing of franchise rights when the awarding government body has to balance between revenue collection and consumer welfare. In this environment, we show that optimal pricing requires an appropriate combination of fixed and time‐variable transfers between the parties. Notably, our findings suggest that it might be optimal to occasionally subsidize rather than charge the franchisee when consumers' willingness to pay increases well beyond initial expectations.