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

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  • Bös, Dieter
  • Lülfesmann, Christoph

Abstract

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.

Suggested Citation

  • Bös, Dieter & Lülfesmann, Christoph, 2001. "Holdups, Quality Choice, and the Achilles' Heel in Government Contracting," Bonn Econ Discussion Papers 28/2001, University of Bonn, Bonn Graduate School of Economics (BGSE).
    • Handle: RePEc:zbw:bonedp:282001
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    More about this item

    Keywords

    Procurement; Incomplete Contracts; Quality Choice; Governance Structure;
    All these keywords.

    JEL classification:

    • D23 - Microeconomics - - Production and Organizations - - - Organizational Behavior; Transaction Costs; Property Rights
    • K12 - Law and Economics - - Basic Areas of Law - - - Contract Law
    • L23 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Organization of Production

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