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Bidding for Contracts: A Principal-Agent Analysis

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Author Info
R. Preston McAfee
John McMillan

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Abstract

This article models the process of bidding for government contracts in the presence of moral hazard. Several (possibly risk-averse) potential contractors (agents) submit sealed bids, on the basis of which the government (principal) selects one to perform a task. The optimal linear contract is derived. The bidding process induces the potential agents to reveal their relative expected costs. The optimal contract trades off giving the chosen agent an incentive to limit costs against stimulating bidding competition and sharing risks. The optimal contract is never cost-plus, may be fixed-price, but is usually an incentive contract. Some prescriptions for government contracting emerge.

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Publisher Info
Article provided by The RAND Corporation in its journal RAND Journal of Economics.

Volume (Year): 17 (1986)
Issue (Month): 3 (Autumn)
Pages: 326-338
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Handle: RePEc:rje:randje:v:17:y:1986:i:autumn:p:326-338

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  1. David Pérez-Castrillo & Nicolas Riedinger, 1999. "Auditing Cost Overrun Claims," CIE Discussion Papers 1999-12, University of Copenhagen. Department of Economics. Centre for Industrial Economics. [Downloadable!]
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  2. Robert C. Feenstra & Tracy R. Lewis & John McMillan, 1990. "Designing Policies to Open Trade," NBER Working Papers 3258, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  3. Surajeet Chakravarty & W. Bentley MacLeod, 2006. "Construction contracts (or "how to get the right building at the right price?")," Discussion Papers 0506-24, Columbia University, Department of Economics. [Downloadable!]
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  4. Rajeev K. Goel & Iftekhar Hasan, 2004. "Funding new ventures: some strategies for raising early finance," Applied Financial Economics, Taylor and Francis Journals, vol. 14(11), pages 773-778, July. [Downloadable!] (restricted)
  5. François MARECHAL & Michel MOUGEOT, 2004. "Risk sharing and moral hazard under prospective payment to hospitals: how to reimburse services for outlier patients," Cahiers de Recherches Economiques du Département d'Econométrie et d'Economie politique (DEEP) 04.03, Université de Lausanne, Faculté des HEC, DEEP. [Downloadable!]
  6. Cornelli, Francesca & Felli, Leonardo, 2001. "How to Sell a (Bankrupt) Company?," CEPR Discussion Papers 2881, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  7. Kerschbamer, Rudolf & Tournas, Yanni, 2000. "In-House Competition, Organizational Slack and the Business Cycle," CEPR Discussion Papers 2557, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
  8. Hans-Werner Sinn & Alfons Weichenrieder, 1997. "Foreign Direct Investment, Political Resentment and the Privatization Process in Eastern Europe," CESifo Working Paper Series CESifo Working Paper No. , CESifo GmbH. [Downloadable!]
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  9. William P. Rogerson, 1988. "Quality vs. Quantity in Military Procurement: An Organizational Theory of Decision Bias," Discussion Papers 771, Northwestern University, Center for Mathematical Studies in Economics and Management Science. [Downloadable!]
  10. Paul H. Jensen & Robin E. Stonecash, 2005. "Contract Efficiency in the Presence of Demand and Cost Uncertainty," Melbourne Institute Working Paper Series wp2005n01, Melbourne Institute of Applied Economic and Social Research, The University of Melbourne. [Downloadable!]
  11. Paul Healy & John Ledyard & Charles Noussair & Harley Thronson & Peter Ulrich & Giulio Varsi, 2007. "Contracting inside an organization: An experimental study," Experimental Economics, Springer, vol. 10(2), pages 143-167, June. [Downloadable!] (restricted)
  12. François MARECHAL, 2003. "Should we base procurement rules on the competition of linear incentive contracts ?," Cahiers de Recherches Economiques du Département d'Econométrie et d'Economie politique (DEEP) 03.07, Université de Lausanne, Faculté des HEC, DEEP. [Downloadable!]
  13. D. K"Ubler, . "Auctioning Off Labor Contracts: Legal Restrictions Reconsidered," Sonderforschungsbereich 373 1996-22, Humboldt Universitaet Berlin.
  14. William W. WILSON & Bruce L. DAHL, 1997. "Bidding On Railcars For Grain: A Strategic Analysis," Reports 376, North Dakota State University Department of Agricultural Economics. [Downloadable!]
  15. Boeheim, Rene & Zulehner, Christine, 1996. "Auctions - A Survey," Economics Series 39, Institute for Advanced Studies. [Downloadable!]
  16. Surajeet Chakravarty & Bentley MacLeod, 2004. "On the Efficiency of Standard Contracts the Case of Construction," Working Papers 874, Princeton University, Department of Economics, Industrial Relations Section.. [Downloadable!]
  17. Rajeev K. Goel, 1999. "On contracting for uncertain R&D," Managerial and Decision Economics, John Wiley & Sons, Ltd., vol. 20(2), pages 99-106.
  18. Flambard,Véronique & Lasserre,Pierre & Mohnen ,Pierre, 2004. "Snow Removal Auctions in Montreal: Costs, Informational Rents, and Procurement Management," Research Memoranda 023, Maastricht : MERIT, Maastricht Economic Research Institute on Innovation and Technology. [Downloadable!]
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  19. Patrick Bajari & Robert S. McMillan & Steve Tadelis, 2003. "Auctions Versus Negotiations in Procurement: An Empirical Analysis," NBER Working Papers 9757, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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