Simple Cost-Sharing Contracts

Leon Yang Chu and David E. M. Sappington

American Economic Review, 2007, vol. 97, issue 1, pages 419-428

Abstract: We extend William Rogerson's (2003) intriguing analysis of simple procurement contracts to settings where the supplier’s innate production cost is not necessarily distributed uniformly. Although the simple contract that Rogerson analyzes performs remarkably well when the smaller cost realizations are relatively likely, it can perform poorly when the larger cost realizations are relatively likely. We show that in all settings under consideration, a simple pair of contracts – one that involves linear cost sharing and one that involves full cost reimbursement – can always secure more than 73 percent of the gain achieved with a fully optimal contract. (JEL D86)

Date: 2007
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