Contract Efficiency in the Presence of Demand and Cost Uncertainty

Melbourne Institute Working Paper No. 1/05

28 Pages Posted: 28 Jan 2005

See all articles by Paul H. Jensen

Paul H. Jensen

University of Melbourne - Melbourne Institute of Applied Economic and Social Research

Robin E. Stonecash

Australian Graduate School of Management

Date Written: January 2005

Abstract

Standard formulations of procurement contract problems analyse the tension between providing performance incentives while allocating risk appropriately. The standard model examines this problem in the context of procuring a single indivisible good that is easily defined but is characterised by uncertainty in the cost of production. In many real-world contracts, however, the procurement environment looks rather different. In this article, we examine contract efficiency in a complex contractual environment for services characterized by cost uncertainty and an unknown level of service provision. Using data on water and sewerage network maintenance services contracts from two Melbourne water retailers, we compare the expenditure across fixed-price and cost-plus service contracts. The results suggest that the fixed-price contracts outperform the cost-plus contracts, thereby confirming the standard result that efficient contracts trade-off risk for incentives.

Keywords: Contract design, uncertainty, risk, outsourcing

JEL Classification: L24, D82

Suggested Citation

Jensen, Paul H. and Stonecash, Robin, Contract Efficiency in the Presence of Demand and Cost Uncertainty (January 2005). Melbourne Institute Working Paper No. 1/05, Available at SSRN: https://ssrn.com/abstract=655581 or http://dx.doi.org/10.2139/ssrn.655581

Paul H. Jensen

University of Melbourne - Melbourne Institute of Applied Economic and Social Research ( email )

Level 5, FBE Building, 111 Barry Street
Parkville, Victoria 3010
Australia

Robin Stonecash (Contact Author)

Australian Graduate School of Management ( email )

Gate 11, Botany Street, Randwick
Sydney, NSW 2052
Australia

Here is the Coronavirus
related research on SSRN

Paper statistics

Downloads
233
Abstract Views
2,053
rank
150,697
PlumX Metrics