20. In many countries, agency relationships between the central government, subnational entities and lenders are made more complex by the existence of several layers of local government, including states, regions, provinces, and counties, as well as by intermunicipal undertakings such as special districts or municipalities associations with an authority to undertake investments and to borrow on the market. The agency problems identified between the central government and sub-national entities will in many cases arise between various levels of local governments, because many intermediate governments have a responsibility to allocate capital grants and/or to lend to lower levels of governments. This intermediate relationships will in many cases magnify the agency problems identified in the basic model presented above, because they lead to a multiple principal-multiple agent situation that is conducive to moral hazard and/or adverse selection on the sub-national debt market.

21. Further difficulties may arise as a result of the existence of local utility companies that are owned and/or regulated by them. While many countries have adopted crosssectoral and sector-specific umbrella laws governing the establishment of infrastructure concessions, the design and implementation of concession arrangements between local governments and local utility companies may be subject to complex agency problems. In particular, information asymmetries between local governments and local utility company operators may lead to moral hazard problems, for example due to difficulties in measuring the effort undertaken by a local utility operator to improve operational efficiency and to cut costs. For example, a recent study of the local government finance market in Hungary has revealed the complexity of the contractual relationships surrounding private sector participation in the management and financing of local utility companies, and the impact of these relationships on local government budgets, both as a result of unclear contractual obligations between the private operator/investor and the local government and as a result of guarantees and other contingent liabilities that are not integrated transparently in the local government budget (see Jokay, Kalman, and Kopanyi 1998, op. cit.).

22. Because project financing of local utility companies is seldom on a pure nonrecourse basis, governments need to establish a legal and regulatory framework that provides a basis for revealing cost structures and measuring efficiency gains by local utilities, and a local government budgetary framework that allows for recording and correctly valuing guarantees and other contingent liabilities incurred by local governments vs local utility companies (see chapter 2, section B below).

23. Citizens can also play a key role in shaping agency relationships on the subnational debt market. _Ex-ante,_ citizens as principals of the local government can have a powerful impact not only on the type of investments undertaken at the local level, but also on the choice of financing instruments for these investments. This is the case for example if local government borrowing is subject to a local referendum, or to a special vote of the city council. This relationship can be made more complex if there is a differential requirement in function of the type of debt issued by the local government. For example, in the US, general obligation bonds are subject to a local referendum, while revenue bonds or lease-backed financing are not, thereby introducing a distortion in the selection of financing instruments by municipalities to finance their investments. _Ex-post,_ citizens as principals of the central and of the local government can influence the _7_