Let us consider a simple modification of the Dewatripoint-Maskin model of the soft budget constraints. 

 Assume that the share of “bad ideas” (1-α) is 10/100 (10%). All projects cost 1 million USD to start (initial financing) regardless of their quality. The subsequent information about revenues are gross, i.e. neither the initial costs nor the costs of the bailout have been subtracted from them.

Bad projects lead to 0 revenue after the first period while good projects will lead to the revenue of 2.5 mil. USD for the enterprise and 1 mil. for the manager (private gain for the manager).

Good projects end after the first period while the delays in bad projects imply that a decision must be made – either to liquidate the project or to save them by a bailout.

In the case of liquidation, the state gets 0.25 mil. USD at the end of the second period (scrap value of the liquidated enterprise), while the manager receives a punishment which has the equivalent of losing 0.5 mil. USD.

In the case of the bailout (with additional costs of 1 mil. USD), the project is allowed to continue for an extra period and it finally leads to the revenue of 1.25 mil. USD for the enterprise and a positive private payoff of 0.5 for the manager.

Analyze the managers’ motivation to attempt to implement a bad project as well as the center’s motivation to provide bailouts.

Assume that the state/center only cares about the revenues for the enterprise (or the scrap value), the profits/losses of the manager are assumed to be her private business.