Procurement Contracting with Time Incentives: Theory and Evidence

In public sector procurement, social welfare often depends on the time taken to complete the contract. A leading example is highway construction, where slow completion times inflict a negative externality on commuters. Recently, highway departments have introduced innovative contracting methods that give contractors explicit time incentives. We characterize equilibrium bidding and efficient design of these contracts. We then gather a unique data set of highway repair projects awarded by the Minnesota Department of Transportation that includes both innovative and standard contracts. Descriptive analysis shows that for both contract types, contractors respond to the incentives as the theory predicts, both at the bidding stage and after the contract is awarded. Next we build a structural econometric model that endogenizes project completion times, and perform counterfactual policy analysis. Our estimates suggest that switching from standard contracts to designs with socially efficient time incentives would increase welfare by over 19% of the contract value; or in terms of the 2009 Mn/DOT budget, $290 million. We conclude that large improvements in social welfare are possible through the use of improved contract design. ∗We are grateful to Mn/DOT for data, and to Rabinder Bains, Tom Ravn and Gus Wagner for their help. We would also like to thank John Asker, Susan Athey, Matt Gentzkow, Ariel Pakes, Chad Syverson and participants at the IIOC, Stony Brook, NBER IO and WBEC conferences for helpful comments and suggestions. Jason Kriss, Tina Marsh, Maryam Saeedi and Connan Snider provided excellent research assistance