Trust and Trustworthiness in Procurement Contracts with Retainage

Matthew Walker, Elena Katok () and Jason Shachat

Working Papers from Chapman University, Economic Science Institute

Abstract: In complex procurement projects, it is difficult to write enforceable contracts that condition price upon quality. Supplier non-performance becomes an acute risk, particularly when there is intense competition for the contract. An established incentive mechanism used to mitigate the problem of supplier non-performance is retainage, in which the buyer sets aside a portion of the purchase price. After project completion, the buyer determines the amount of retainage that is released to the seller, considering any defects that arise. While generally a feasible contract form to implement, the practical difficulties in assessing completion introduce a moral hazard for the buyer. We develop a structurally new game and experimental design to offer managerial insights on how retainage principles mediate trust and trustworthiness in competitive procurement settings with moral hazard. The experimental results suggest that if trust in the procurement relationship is strong enough, then retainage can mitigate the seller-side moral hazard problem and substitute for reputation in a fragmented supply chain, at the cost of inflated tender prices. In high retainage structures, there is a trade-off between trade efficiency and supplier participation in request for bids. We further develop a model of fair payment norms and offer managerial insights on how to design the retainage mechanism, conditional on prevailing levels of trust and beliefs about fairness.

Keywords: trust; procurement; reverse auction; retainage; moral hazard (search for similar items in EconPapers)
JEL-codes: C92 D86 L15 (search for similar items in EconPapers)
Date: 2020
New Economics Papers: this item is included in nep-com, nep-cta, nep-des, nep-exp, nep-hrm, nep-mic and nep-soc
References: View references in EconPapers View complete reference list from CitEc
Citations:

Downloads: (external link)
https://digitalcommons.chapman.edu/esi_working_papers/329/

Related works:
Journal Article: Trust and Trustworthiness in Procurement Contracts with Retainage (2023)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:chu:wpaper:20-34

Access Statistics for this paper

More papers in Working Papers from Chapman University, Economic Science Institute Contact information at EDIRC.
Bibliographic data for series maintained by Megan Luetje ().