THIRD-PARTY OPPORTUNISM AND THE THEORY OF PUBLIC CONTRACTS: - - PowerPoint PPT Presentation

THIRD-PARTY OPPORTUNISM AND THE THEORY OF PUBLIC CONTRACTS: OPERATIONALIZATION AND APPLICATIONS

Marian Moszoro

IESE Business School, Barcelona

Pablo Spiller

University of California, Berkeley & NBER

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• inefficient
• low quality
• delays
• corruption
• expensive
• bureaucratic
• intricate
• convoluted
• controls
• inspections
• courts, protests
• ...

Public Contracts...

... Third Parties not necessarily interested in the success of the contract

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Research Question

• Why public contracts look „inefficient” and „expensive”?

Other related questions we try to tackle:

• Why public servants are less productive?
• Why China builds infrastructure more efficiently than

developed countries?

• Can small municipalities be efficient?
• Why privatizations don’t capture all corporate value?
• Does immunity of public officials help public

contracting?

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Findings

• Third-party opportunism (TPO) as quintessential

hazard of public transactions

• Public agents minimize political third-party cost with

contract specificity and rigidity, which induce high contracting prices

• High specificity and rigidity, and high prices is a

Bayesian Nash equilibrium of public contracts

• True inefficiency in public contracting should pass

Williamson’s (1999) remediableness test

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Related Literature

• Industrial Organization (Bajari & Tadelis 2001, Hart & Moore 2008,

Laffont & Tirole 1993, Loeb & Surysekar 1994, Macaulay 1963, Marshall, Meurer & Richard 1994):

→ informational asymmetries, verifiability of information, and repeated interactions

• Public Administration (Baldwin 1990, Boyne 2002, Bozeman 1993,

Kurland & Egan 1999, Layne & Rainey 1992, Prendergast 2003)

→ formal processes essential to the public sector's functions and “red tape”

• Political Economy (Buchanan 1965, de Figueiredo, Spiller &

Urbiztondo 1999, McCubbins & Schwartz 1984, Olson 1965, Riker 1963, Stigler 1971):

→ public interest theory vs. interested group (“capture”) theory, both demand and supply-side of political decision making

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Public agent (a) Private contractor (b) Specific and rigid contract Political competitor Court General public (d) Challenger (c)

Because of its nature, every person has a stake in a public contract Third parties may challenge public contracts either through polls or in court To avoid third-party

• pportunism from

challengers, the government and the private contractor engage in a highly specific and rigid contract

TPO Singalling

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Defining Specificity and Rigidity

• Contract specificity: ex ante complexity of subject,

completeness of clauses and technical provisions

• Contract rigidity: ex post enforcement, penalties,

hardness and intolerance to adaptation of contracts

• Rigidity correlates with specificity: the more specific

the contract is, the more rigid its implementation and enforcement it is expected to be

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Modeling Hazards, Rigidity, and Pricing

• T ฀ political costs of the loss of office, reputation and support. If

the challenge is successful, they also include social costs of a new tender, i.e., time and documentation

• K ฀ Contracting (ex ante), and implementation and enforcement

(ex post) costs (time, lawyers, documentation and control)

•  ฀ likelihood of TPO challenge
•  ฀ likelihood of success of TPO challenge

Proposition 1 Expected political third-party opportunism costs E(T) are decreasing and strictly convex in rigidity R Proposition 2 Contracting and enforcement costs K are rising and convex in rigidity R

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Optimal Contract Specificity/Rigidity

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Optimal Contract Specificity/Rigidity

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Scrutiny: A Two-Sided Sword

• Public accountability, transparency, and public participation increase

the level of internalization of contracting costs by the public agent

• On the other hand, better informed third parties due to scrutiny may

increase or decrease the likelihood of TPO

• Hence, it is equivocal whether open information policies (as the case
• f the State of California) lead to more efficient public contracts

Proposition 1 Assuming away administrative scrutiny costs, an increase in scrutiny increases public contracting efficiency only if the internalization of contracting costs effect is larger than the increase

• f political costs effect due to access to information of opportunistic

third parties

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User Cases

MODELS = should simplify the understanding of reality

• Bureaucracies
• Fixed-Price vs. Cost-Plus Contracts
• PPPs and Key Performance Indicators
• Public-to-Public Contracts
• External Consultants and Certification of Contractors
• Efficient Small Communities and Authoritarian Regimes
• Privatization of Government-Owned Companies
• Immunity for Public Agents

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Future Research: Comparative Statics

• Services vs. production/construction
• Socially sensitive (water, security) vs. non-sensitive
• Short-term (garbage) vs. long-term effects (education)
• Search goods (commodities) and experience goods (utilities)

(Nelson 1970) vs. credence goods (health care, education) (Darby and Karni 1973; Arrow 1963) Our intuition: socially sensitive, long-term services contracts for credence goods are more subject to potential TPO challenge and hence contract rigidity due to the fact that by nature these contracts are more complex

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An Extension: Governmental Opportunism

• TPO model can serve to analyze government opportunism (G)
• A = expropriation rents
•  = likelihood of government opportunism of appropriating A
• E(G) =  A, where 

 / R < 0, and total expected costs of

• pportunism equal E(T) + E(G)
• For any  > 0, ฀I ฀ ฀A, ฀E(G) (Troesken 1996) ฀ R’ > R*
• It is the private contractor who seeks further R’
• Gov. opportunism ฀ P’ > P* ฀ more vulnerable to TPO
• Political risk insurance lowers the E(G) curve, but increases the

cost of contracting K and final price of the contract P

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An Extension: Governmental Opportunism

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Conclusions and Policy Recommendations

• TPO theory combines political hazards and

contracting costs to explain apparent inefficiencies in public contracts

• Public agents minimize political third-party cost with

contract specificity and rigidity, which induce high contracting prices

• High specificity and rigidity, and high prices of public

contracts is a Bayesian Nash equilibrium

• True inefficiency in public contracting should pass

Williamson’s (1999) remediableness test

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