Implications of Third Parties for Contract Design

We analyze the implications of plausible third-party challenges to the legitimacy of a transaction for contract design. To the extent that such challenges impose reputation and transaction costs, the scrutinized agent has an incentive to choose contractual procedures that make challenges less likely to succeed at court, thereby discouraging the filing of challenges in the first place. The added contractual proceduralization, in turn, create adaptation costs for both the agent and the contractor which are externalized to the principals, making the transaction allegedly inefficient. This setup is of particular relevance in public procurement, where interested third parties—political opponents, excluded bidders, and watchdogs—are always present due to the nature of the transaction.