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Incentives versus Transaction Costs: A Theory of Procurement Contracts

Posted: 15 Aug 2001  

Patrick Bajari

University of Michigan at Ann Arbor - Economics; National Bureau of Economic Research (NBER)

Steven Tadelis

University of California, Berkeley - Haas School of Business; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

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Abstract

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

Bajari, Patrick and Tadelis, Steven, Incentives versus Transaction Costs: A Theory of Procurement Contracts. RAND Journal of Economics, Vol. 32, No. 3. Available at SSRN: https://ssrn.com/abstract=276130

Patrick Bajari

University of Michigan at Ann Arbor - Economics ( email )

266 Lorch Hall
Ann Arbor, MI 48109
United States
734-763-5319 (Phone)

HOME PAGE: http://www-personal.umich.edu/~bajari/

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Steven Tadelis (Contact Author)

University of California, Berkeley - Haas School of Business ( email )

545 Student Services Building, #1900
2220 Piedmont Avenue
Berkeley, CA 94720
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Centre for Economic Policy Research (CEPR) ( email )

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

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