Robustness of simple menus of contracts in cost-based procurement |
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| Institution: | 1. Department of Government, University of Essex, Wivenhoe Park, Colchester CO4 3SQ, United Kingdom;2. Faculty of Engineering, Information and Systems, University of Tsukuba, 1-1-1 Tennodai, Tsukuba, Ibaraki 305-8573, Japan;3. WZB Berlin Social Science Center, Reichpietschufer 50, D-10785 Berlin, Germany;4. Department of Economics, University of Heidelberg, Bergheimer Str. 58, 69115 Heidelberg, Germany;1. ICREA, Universitat Pompeu Fabra and Barcelona GSE, Spain;2. Universitat Autonoma de Barcelona and Barcelona GSE, Spain;3. University of Michigan, United States;1. University of Cologne, Department of Economics, Albertus-Magnus Platz, D-50923 Cologne, Germany;2. Department of Economics, University of Essex, Wivenhoe Park, Colchester CO4 3SQ, United Kingdom;1. eBay Data Labs, United States;2. Harvard University, United States;3. Harvard Business School, United States |
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| 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. |
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| Keywords: | Cost-based procurement Simple mechanisms Minimax |
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