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Incentives versus Transaction Costs: A Theory of Procurement Contracts

  • Bajari, Patrick
  • Tadelis, Steven

Inspired by facts from the private-sector construction industry, we develop a model that explains many stylized facts of procurement contracts. The buyer in our model incurs a cost of providing a comprehensive design and is faced with a tradeoff between providing incentives and reducing ex post transaction costs due to costly renegotiation. We show that cost-plus contracts are preferred to fixed-price contracts when a project is more complex. We briefly discuss how fixed-price or cost-plus contracts might be preferred to other incentive contracts. Finally, our model provides some microfoundations for ideas from Transaction Cost Economics. Copyright 2001 by the RAND Corporation.

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

Volume (Year): 32 (2001)
Issue (Month): 3 (Autumn)
Pages: 387-407

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Handle: RePEc:rje:randje:v:32:y:2001:i:3:p:387-407
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