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

Dieter Bös and Christoph Lülfesmann

No 28/2001, Bonn Econ Discussion Papers from University of Bonn, Bonn Graduate School of Economics (BGSE)

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.

Keywords: Procurement; Incomplete Contracts; Quality Choice; Governance Structure (search for similar items in EconPapers)
JEL-codes: D23 K12 L23 (search for similar items in EconPapers)
Date: 2001
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Persistent link: https://EconPapers.repec.org/RePEc:zbw:bonedp:282001

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