Public sector procurement: lump-sum payments or optimal contracts

Levine, P and Rickman, N (2000) Public sector procurement: lump-sum payments or optimal contracts. Working Paper. London Business School Regulation Initiative Working Paper Series.

Abstract

In a dynamic setting we compare procurement schemes in the form of a lumpsum payment with an optimal informationrevealing menu of contracts without commitment. We find that lumpsum contracts generate two benefits. First, they always provide optimal levels of effort. Second, they 'tie the hands' of the procuruer and avoid the ratchet effect. These benefits must be weighted against the costs of higher rent in the second period. For a low discount factor such costs dominate, but for a high discount rate, when the ratchet effect becomes acute, the welfare gap becomes small and lumpsum payments may even welfaredominate an optimal menu.