Incentives Versus Transaction Costs: A Theory of Procurement Contracts
Stanford University, Department of Economics Working Paper No. 99-029
33 Pages Posted: 16 Nov 1999
Date Written: April 2001
Inspired by facts from the private sector construction industry, we develop a model that explains many stylized facts of procurement contracts. The buyer in our model incurs a cost of providing a comprehensive design, and is faced with a trade-off between providing incentives and reducing ex post transaction costs due to costly renegotiation. We show that cost plus contracts are preferred to fixed price contracts when a project is more complex. We briefly discuss how fixed-price or cost-plus contracts might be preferred to other incentive contracts. Finally, our model provides some micro-foundations for ideas from Transaction Cost Economics.
JEL Classification: D23, D82, L14, L22, L74
Suggested Citation: Suggested Citation