Foundations for Simple Menus of Contracts in Cost- Based Procurement*

This paper considers a model of cost-based procurement in which the principal faces ambiguity about the agent's preferences for e ort to reduce costs. It evaluates the performance of simple and commonly used incentive schemes whereby the agent chooses between a xed-price contract and a cost-reimbursement contract. Calculation of the optimal simple scheme requires knowledge only of the cost saving from e cient e ort and the distribution of the innate cost { the agent's cost of production without e ort. The paper argues that the optimal simple scheme can be a \robust" choice given only this information. Two criteria are considered: (1) whether the scheme minimizes the maximum expected payment, and (2) whether the scheme is undominated. Whilst there is always a simple scheme that solves the minimax problem, the question of (weak) dominance is more delicate. It depends on the principal's view about whether the agent's preferences for e ort depend on his monetary rewards. If the principal believes that they might, then the optimal simple scheme is undominated. JEL classi cation: H57, L51, C44