PNS340 THE THEORY OF CONTRACTS AND WARRANTIES: IMPLICATIONS FOR OUTCOMES-BASED CONTRACTING

Abstract

Outcomes-based contracts (OBCs) are a type of performance-based risk sharing agreement designed to optimally share or allocate risk between buyers and sellers, especially in value-based pricing (VBP) scenarios. OBCs are a form of warranty, similar to those common to many other industries, such as automobiles. In this paper, we create a conceptual framework through which to identify important concepts and lessons from institutional economics and warranty theory to potentially improve OBC design. A search for OBCs was carried out in PubMed database, in addition to a general Google search. Studies pertaining to OBCs were included, in addition to trade press articles and consulting reports, in order to develop the develop an understanding of existing OBC designs. Concurrently, based on the institutional economics literature on warranties, we developed a conceptual framework of risk-based warranty contracts. Warranties are part contractual apparatus, the primary goal of which is to allocate risk, and part signaling mechanism, the primary goal of which is to credibly signal product and service quality. Together, both attributes are designed to reduce transaction costs associated with uncertainty and asymmetric information. Most OBCs are designed as simple risk sharing mechanisms, and ignore the importance of quality signaling and how quality signaling can inform the design of optimal risk sharing arrangements. There is a large literature on the institutional economics of warranties, but little of that has been applied to OBCs in the health industry. In developing a novel conceptual framework of warranties and parallels with OBCs, we offer some guidance on improving the design of the next generation of OBCs.