Foundations for Simple Menus of Contracts in Cost-Based Procurement

23 Pages Posted: 22 Mar 2009 Last revised: 10 Oct 2012

See all articles by Daniel Ferguson Garrett

Daniel Ferguson Garrett

University of Toulouse 1 - Toulouse School of Economics (TSE)

Date Written: February 22, 2009

Abstract

We consider a model of cost-based procurement in which the principal faces Knightian uncertainty about the agent's preferences for cost reduction. We show that a particularly simple incentive scheme --- a menu comprising a fixed-price contract and a cost-reimbursement contract --- minimizes the maximum expected payment, where this maximum is taken over the set of possible agent preferences. For some parameters of the problem, a range of alternative incentive schemes also satisfy this criterion. We show that the simple incentive scheme is not weakly dominated by any of the alternatives: there does not exist an alternative mechanism for which the expected payment is no higher for all realizations of the agent's preferences and strictly lower for some realization.

Keywords: procurement, simple mechanisms, minimax

JEL Classification: H57, L51, C44

Suggested Citation

Garrett, Daniel Ferguson, Foundations for Simple Menus of Contracts in Cost-Based Procurement (February 22, 2009). Available at SSRN: https://ssrn.com/abstract=1365509 or http://dx.doi.org/10.2139/ssrn.1365509

Daniel Ferguson Garrett (Contact Author)

University of Toulouse 1 - Toulouse School of Economics (TSE) ( email )

Place Anatole-France
Toulouse Cedex, F-31042
France

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