DP4540 Contract Renewal and Incentives in Public Procurement

Author(s): Dag Morten Dalen, Espen R Moen, Christian Riis
Publication Date: August 2004
Keyword(s): contract renewal, public procurement, quality, tournament
JEL(s): D44, L33, L51
Programme Areas: Public Economics, Industrial Organization
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=4540

This Paper explores how the government?s choice of renewal policy in public procurement programmes can be used as a mechanism to provide firms with incentives to supply quality. Several firms produce a public service. The firms participate in a tournament where they are ranked according to the quality of their services, and rewarded in terms of contract renewals. We analyse the firms? incentives to produce high-quality services, and find that they are maximized if 50% of the contracts are renewed. The optimal renewal policy trades off incentive provision (which requires that a relatively large fraction of the firms are replaced each period) against the entry costs of new firms.