American Economic Review Vol. 97 No. 1 2007

Simple Cost-Sharing Contracts

Leon Yang Chu¹; David E. M. Sappington²

¹ Department of Information and Operations Management, BRI-401, mc 0809, 3670 Trousdale Parkway, University of Southern California, Los Angeles, CA 90089. · ² Department of Economics, P.O. Box 117140, University of Florida, Gainesville, FL 32611.

Abstract

We extend William Rogerson's (2003) intriguing analysis of simple procurement contracts to settings where the supplier's innate production cost is not necessarily distributed uniformly. Although the simple contract that Rogerson analyzes performs remarkably well when the smaller cost realizations are relatively likely, it can perform poorly when the larger cost realizations are relatively likely. We show that in all settings under consideration, a simple pair of contracts – one that involves linear cost sharing and one that involves full cost reimbursement – can always secure more than 73 percent of the gain achieved with a fully optimal contract.

DOI

10.1257/aer.97.1.419

Volume

97

Issue

1

Pages

419-428

Language

en

Sources

openalex bibtex:phds-export.bib crossref

Cite

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