Zhechen Yu

Job market paper

Uncertainty and Incomplete Contracts in Procurements

When a buyer is uncertain whether a good/service design can fulfill the need of the purchase, the buyer is unable to write a complete contract, which may lead to a costly modification ex-post. In this paper, I study how the buyer's uncertainty affects the seller-selection process and contract price. The buyer tries to maximize his/her expected payoff by choosing a selection process and subsequently negotiating a price that accounts for the hold-up cost and the cost of modification. I gather a sample of federal service procurement contracts solicited through either a competitive or a non-competitive process with potential modifications observed ex-post. Empirically, to solve the endogenous selection issue, I adapt the Extended Roy Model with a predicted likelihood of modification. I find that, with less uncertainty or more market competition, it is more likely that the service will be procured through a competitive process. Moreover, ceteris paribus, when the uncertainty goes up, contract prices drop more in services procured through the non-competitive process than those procured through the competitive process.