Foundations for Simple Menus of Contracts in Cost-Based Procurement
23 Pages Posted: 22 Mar 2009 Last revised: 10 Oct 2012
Date Written: February 22, 2009
We consider a model of cost-based procurement in which the principal faces Knightian uncertainty about the agent's preferences for cost reduction. We show that a particularly simple incentive scheme --- a menu comprising a fixed-price contract and a cost-reimbursement contract --- minimizes the maximum expected payment, where this maximum is taken over the set of possible agent preferences. For some parameters of the problem, a range of alternative incentive schemes also satisfy this criterion. We show that the simple incentive scheme is not weakly dominated by any of the alternatives: there does not exist an alternative mechanism for which the expected payment is no higher for all realizations of the agent's preferences and strictly lower for some realization.
Keywords: procurement, simple mechanisms, minimax
JEL Classification: H57, L51, C44
Suggested Citation: Suggested Citation