DP4540 Contract Renewal and Incentives in Public Procurement

Author(s): Dag Morten Dalen , Espen R Moen , Christian Riis

Publication Date: August 2004

Keyword(s): public procurement , quality , tournament , contract renewal

JEL(s): D44 , L33 , L51

Programme Areas: Industrial Organization , Public Policy

Link to this Page: www.cepr.org/pubs/dps/DP4540.asp

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.