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

Public Contracts... • inefficient • intricate • low quality • convoluted • delays • controls • corruption • inspections • expensive • courts, protests • bureaucratic • ... Marian Moszoro, Pablo Spiller 2

... Third Parties not necessarily interested in the success of the contract Marian Moszoro, Pablo Spiller 3

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? Marian Moszoro, Pablo Spiller 4

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 Marian Moszoro, Pablo Spiller 5

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 Marian Moszoro, Pablo Spiller 6

TPO Singalling General public (d) Because of its nature, every person has a stake in a public contract Political Challenger (c) Court competitor Third parties may challenge public contracts either through polls or in court Private Public agent (a) contractor (b) To avoid third-party opportunism from challengers, the government and the private contractor Specific and engage in a highly specific and rigid contract rigid contract Marian Moszoro, Pablo Spiller 7

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 Marian Moszoro, Pablo Spiller 8

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 Marian Moszoro, Pablo Spiller 9

Optimal Contract Specificity/Rigidity Marian Moszoro, Pablo Spiller 10

Optimal Contract Specificity/Rigidity Marian Moszoro, Pablo Spiller 11

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 of 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 of political costs effect due to access to information of opportunistic third parties Marian Moszoro, Pablo Spiller 12

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 Marian Moszoro, Pablo Spiller 13

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 Marian Moszoro, Pablo Spiller 14

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 opportunism 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 Marian Moszoro, Pablo Spiller 15

An Extension: Governmental Opportunism Marian Moszoro, Pablo Spiller 16

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 Marian Moszoro, Pablo Spiller 17

Pablo Spiller, Marian Moszoro 18