Dynamic Procurement under Uncertainty: Optimal Design and Implications for Incomplete Contracts
American Economic Review · 2016 · Volume 106 · Issue 11
Abstract
We characterize the optimal dynamic contract for a long-term basic service when an uncertain add-on is required later on. Introducing firm risk aversion has two impacts. Profits for the basic service can be backloaded to induce cheaper information revelation for this service: an Income Effect which reduces output distortions. The firm must also bear some risk to induce information revelation for the add-on. This Risk Effect reduces the level of the add-on but hardens information revelation for the basic service. The interaction between these effects has important implications for the dynamics of distortions, contract renegotiation, and the value of incomplete contracts.
Keywords
Firm Behavior: Theory, Criteria for Decision-Making under Risk and Uncertainty, Asymmetric and Private Information, Mechanism Design, Economics of Contract: Theory, Financing Policy, Financial Risk and Risk Management, Capital and Ownership Structure, Value of Firms, Goodwill
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