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Ambiguity Aversion and Cost-Plus Procurement Contracts

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  • Sujoy Mukerji

Abstract

This paper provides a positive theory about the contractual form of procurement contracts under cost uncertainty. However, while the cost of manufacture is uncertain it can be reduced by an amount depending on the extent of effort exerted by the agent. The effort exerted by the agent is not verifiable but causes disutility to the agent, hence, its extent will ultimately depend on the power of incentives built into the terms of reimbursement agreed to in the contract. The analysis in the paper explicitly models the possibility that the agent’s beliefs are ambiguous and the agent is ambiguity averse. The principal finding is that the greater the ambiguity/ambiguity aversion of the agent, the lower the power of the incentive scheme incorporated in the terms of reimbursement included in the optimal contract.

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Bibliographic Info

Paper provided by University of Oxford, Department of Economics in its series Economics Series Working Papers with number 112.

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Date of creation: 01 Jul 2002
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Handle: RePEc:oxf:wpaper:112

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Related research

Keywords: procurement; incentive contracts; uncertainty aversion; cost-plus contracts; fixed price contracts;

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Cited by:
  1. Karni, Edi, 2009. "A reformulation of the maxmin expected utility model with application to agency theory," Journal of Mathematical Economics, Elsevier, vol. 45(1-2), pages 97-112, January.
  2. Philipp Weinschenk, 2010. "Moral Hazard and Ambiguity," Working Paper Series of the Max Planck Institute for Research on Collective Goods 2010_39, Max Planck Institute for Research on Collective Goods.

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