Ambiguity Aversion and Cost-Plus Procurement Contracts

Sujoy Mukerji

No 112, Economics Series Working Papers from University of Oxford, Department of Economics

Abstract: This paper provides a positive theory about the contractual form of procurement contracts under cost uncertainty. However, while the cost of manufacture is uncertain it can be reduced by an amount depending on the extent of effort exerted by the agent. The effort exerted by the agent is not verifiable but causes disutility to the agent, hence, its extent will ultimately depend on the power of incentives built into the terms of reimbursement agreed to in the contract. The analysis in the paper explicitly models the possibility that the agent’s beliefs are ambiguous and the agent is ambiguity averse. The principal finding is that the greater the ambiguity/ambiguity aversion of the agent, the lower the power of the incentive scheme incorporated in the terms of reimbursement included in the optimal contract.

Keywords: procurement; incentive contracts; uncertainty aversion; cost-plus contracts; fixed price contracts (search for similar items in EconPapers)
JEL-codes: D80 D81 D82 D89 (search for similar items in EconPapers)
Date: 2002-07-01
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Citations: View citations in EconPapers (3)

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