Procurement, Incentives and Bargaining Friction: Evidence from Government Contracts

32 Pages Posted: 19 Feb 2008 Last revised: 4 May 2010

See all articles by John J. Horton

John J. Horton

New York University (NYU) - Department of Information, Operations, and Management Sciences

Date Written: February 17, 2008

Abstract

A transaction cost theory of procurement developed by Bajari and Tadelis (2001) models the buyer's choice of incentive structure as endogenous, with buyers trading off the efficiency of high-powered incentives against the ex post bargaining friction these incentives can create. The source of the bargaining friction is assumed to be asymmetric information between the buyer and seller about the true costs of adapting the project to changed conditions. Using government contract data and an instrument based on contracting-office idiosyncratic variation in preference for various contractual forms, I estimate the effect of a buyer choosing a fixed-price (i.e., high-powered) contract on the probability that the contract will lead to litigation, which proxies for bargaining failure and friction. I find that (a) fixed-price contracts are far more likely to be litigated that cost-plus contracts and (b) the instrumental variables estimate of the effect of choosing a fixed-price structure is almost twice as larges as the biased, OLS estimate. These results are consistent with the main predictions of the Bajari and Tadelis model.

Keywords: Procurement, Transaction Costs, Bargaining Friction, Instrumental Variables

JEL Classification: D23, D73, K41

Suggested Citation

Horton, John J., Procurement, Incentives and Bargaining Friction: Evidence from Government Contracts (February 17, 2008). Available at SSRN: https://ssrn.com/abstract=1094622 or http://dx.doi.org/10.2139/ssrn.1094622

John J. Horton (Contact Author)

New York University (NYU) - Department of Information, Operations, and Management Sciences ( email )

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