IT Outsourcing Auctions With Bilateral Efforts and Renegotiation

Abstract

In information technology outsourcing (ITO), contracts are often awarded through reverse auctions, and renegotiations usually take place for contract amendment after the transaction parties exert joint efforts in project quality improvement. This paper studies an ITO contracting model with the above characteristics from a game-theoretical perspective. We examine the buyer’s design of the initial project scope (which can be renegotiated afterward) and investigate the value of renegotiation to the buyer. The results show that a higher initial scope reduces both the information rent and the effort incentive of the winning provider, and the buyer’s optimal initial project scope is expected to be adjusted upward in the renegotiation. The possibility of renegotiation has effects of both incentivizing the provider effort and generating information rent, but our analytical results show that the former effect is dominant, implying that both the buyer and the provider benefit from the possibility of renegotiation.