Choosing Among Contractor Ownership Types with Endogenously Incomplete Contracts
Abstract: When contracting is difficult, there is the risk of opportunistic behavior by the contractor. Strong incentives for cost savings, for example, can also induce strong incentives to look for loopholes. One well-known solution is to bring the activities in house and provide them with employees facing relatively weak incentives. In this paper, I investigate an alternative approach, outsourcing to nonprofits, that maintains some of the advantages of outsourcing but provides dulled incentives for both good and bad efforts. I find the conditions under which contracting with non-profit is preferable to a similarly-situated for-profit. With exogenously incomplete contracts, the non-profit becomes more attractive as the harm of opportunistic behavior increases, as the degree of incompleteness increases, and (in a repeated game), as the parties become less patient. When the buyer can choose the level of contractual completeness, however, things change. Nonprofits are more attractive as the cost of contractual completeness increases, the scope for cost-reducing effort decreases, and (surprisingly) for intermediate levels of patience and intermediate harms from opportunistic behavior. The intuition for this monotonicity is that when the risks are severe the buyer will choose to write very complete contracts, which, in turn, make for-profit contractors attractive.
