Incentives versus Transaction Costs: A Theory of Procurement Contracts
University of Michigan at Ann Arbor - Economics; National Bureau of Economic Research (NBER)
University of California, Berkeley - Haas School of Business; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)
RAND Journal of Economics, Vol. 32, No. 3
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
Date posted: August 15, 2001