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Holdups, Quality Choice, and the Achilles' Heel in Government Contracting

  • Dieter Bös
  • Christoph Lülfesmann

This paper investigates a procurement relationship between a welfare-oriented government and a private supplier. The agents face several versions of the trading good which differ in quality and production costs, and the differences between those items are undescribable ex ante. In presence of this `quality-choice problem', no initial contract may induce efficient cost-reducing investments of the supplier. In contrast, a first-best result is always attainable in private procurement where the buyer maximizes profit rather than welfare. We identify the government's welfare objective as its Achilles' heel: equilibrium trade prices differ in public and private procurement, and private governance can lead to more efficient investment decisions even though renegotiation ensures the ex-post efficient trade decision in either regime.

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Paper provided by University of Bonn, Germany in its series Bonn Econ Discussion Papers with number bgse28_2001.

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Length: 35
Date of creation: Aug 2001
Date of revision:
Handle: RePEc:bon:bonedp:bgse28_2001
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Bonn Graduate School of Economics, University of Bonn, Adenauerallee 24 - 26, 53113 Bonn, Germany

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Web page: http://www.bgse.uni-bonn.de

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