Contract Renewal and Incentives in Public Procurement

Abstract

This Paper explores how the government's choice of renewal policy in public procurement programs can be used as a mechanism to provide firms with incentives to supply quality. Several firms produce a public service. The firms participate in a tournament where they are ranked according to the quality of their services, and rewarded in terms of contract renewals. We analyze the firms' incentives to produce high-quality services, and find that they are maximized if 50% of the contracts are renewed. The optimal renewal policy trades off incentive provision (which requires that a relatively large fraction of the firms are replaced each period) against the entry costs of new firms.

Keywords: Public procurement, quality, tournament, contract renewal

JEL Classification: D44, L33, L51