Transacting under a performance-based contract: The role of negotiation and competitive tendering

Abstract

There is a growing body of theoretical and empirical evidence to support the promotion of awarding mechanisms with formal and informal devices, aimed at economic efficiency and effectiveness through the life of the contract, i.e., ex ante and ex post coordination. Building on growing arguments to support negotiations instead of auctions, Bajari et al. [Bajari, P., McMillan, R., Tadelis, S., 2002. Auctions versus Negotiations in Procurement: An Empirical Analysis, Department of Economics, Stanford University, October] suggest that auctions perform poorly when projects are complex and contractual design is incomplete. Areawide contracts in bus and rail appear to fit this circumstance, in contrast to somewhat simple and relatively unambiguous bus route contracts. This literature argues theoretically and empirically that auctions (i.e., competitive tendering) can stifle communication between buyers (i.e., the regulator) and sellers (i.e., the service provider), preventing the buyer from utilising the contractor’s expertise when designing the project. A growing number of authors promote the case for greater emphasis on establishing a credible regulatory scheme able to govern the procurement of public services ex post, and that focusing on introducing market mechanisms via competitive tendering per se does not guarantee better value for money. Implicit in the arguments is the need to develop trusting partnerships and (incomplete) commercial contracts with unambiguous incentive and penalty structures throughout the life of a contract, with market mechanisms such as competitive tendering always present as a way forward when operators fail to comply under reasonable notice. This paper develops these themes as a way of gaining a better understanding of negotiated performance-based contracts.