Article

Robustness of simple menus of contracts in cost-based procurement

Daniel F. Garrett

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

Cost-based procurement; Simple mechanisms; Minimax;

JEL codes

  • C44: Operations Research • Statistical Decision Theory
  • H57: Procurement
  • L51: Economics of Regulation

Reference

Daniel F. Garrett, Robustness of simple menus of contracts in cost-based procurement, Games and Economic Behavior, vol. 87, September 2014.

Published in

Games and Economic Behavior, vol. 87, September 2014