SSA – 2016 - 1

Stéphane Saussier Saussier@univ-paris1.fr

http://www.webssa.net

MBA Social Leadership University Ben Gurion

« The specificities of public-private contracting »

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NPOs and contracting

• NPOs have to contract with: •  Employees •  Partners •  Private firms •  Governments

• Because they differ from private firms, they may contract differently and have drawbacks and some « competitive advantage » compared to private firms in some specific situations

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Punchline of the talk

•  Contracting (70’s! now) •  Complete vs. incomplete contracts •  Many identified issues and (imperfect) solutions

•  Public contracting differs (08!now) •  Third party opportunism •  Many solutions that works for private contracts don’t for public ones

•  Parallels with and implications for NPOs •  NPOs are lying between public and private entities and are susceptible

to contract with both

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I. Contracting

(Contingent) Complete contracts

No uncertainty

Rationality

Efficient courts

Asymmetric information

Jean Tirole - TSE

Incentive theory •  Adverse selection •  Moral Hazard

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I. Contracting

Incomplete contracting

Uncertainty

Bounded rationality

Inefficient courts

Specific Investments

Transaction cost theory •  Incomplete contracts •  opportunism

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Issues associated with long term incomplete contracts

Choice of a partner

Competition for the contract

Contract renewal

Competition for the contract

Service specification

Contract execution

t

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Issues – Step 1 – Selection.

•  The difficulties to put firms in « competition for the contract »

•  Price criteria does not always resume what is expected from the partner

•  Aggressive bids !and then quality shading

•  “Winners’ curse” •  Collusion: ex: case of urban

transport in France (2005) – penalty 12M€

•  Corruption: anti-corruption law in France in 1993

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Potential (imperfect) solutions

•  Winners’ curse and contracts that adapt to different scenarios

Ex: Building a new nursery

Needed revenues

D1 D2 D3

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Issues – Step 2 -- enforcement.

•  Difficulties to enforce (incomplete) contractual agreements

•  Disconnection between price and costs over time

•  Penalties are difficult to apply •  Non-verifiable dimensions of the contract

•  Opportunistic behaviors might arise •  Efforts to evade or renegotiate the contract

(Guasch 2004) •  Underinvestment •  Lower level of quality than promised (but not

enforceable) •  Absence of responsiveness to consumer’s

needs •  Connected to the kind of PPPs contract

– Concession vs. PFI

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Jamie Oliver

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One example of opportunistic behavior

•  « But it is difficult to be clear and comprehensive in defining service targets. Governments tend to be nervous about providing only general performance obligations, fearing that the concessionaire will do less than they deem necessary. An example in the United Kingdom helps show why. In the competition for a build-operate transfer (BOT) contract for a prison, granted under the country’s private finance initiative, it turned out that the winning company’s bid was based on a plan to house several prisoners in each cell. The government had wanted single occupancy, but had forgotten to specify this in the tender documents. »

M. Klein, World Bank, Bidding for Concessions—The Impact of Contract Design, 1998

http://siteresources.worldbank.org/EXTFINANCIALSECTOR/Resources/282884-1303327122200/158klein.pdf

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Issues – Step 3

• Specific Investments ⇒ Long term contracts ⇒ Lack of bidding parity at contract renewal time (« Fundamental transformation ») – Lock-in effect

•  Water sector and urban transport in France: 90% of renewed contracts with the same firm!

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One solution : the use of relational contracts

•  Incomplete self-enforcing contracts •  Let’s sign « light » contracts and adapt informally as soon as

uncertainty is resolved over time. •  A relational contract is a contract whose effect is based upon a

relationship of trust between the parties. •  Trust can be calculated, based on the value of future

relationships •  Formalized with repeated game theory / trigger strategy

•  Opportunism ! R = 40; Respect of the spirit of the contract ! R = 20•  40 <? 20 + ß.20 + ß2.20 + ß3.20+… " ß > 0.5

•  BUT are relational contracts an option for public contracts?

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II. Public contracting differs

•  Public contracts are often associated with: •  Inefficiencies, low quality, delays, expensive, corruption,

favoritism, bureaucratic, red tape, politics, intricate, convoluted, scrutiny, regulation, controls, inspections, protests, courts

•  Those contracts are clearly different from private ones

--> What is intrinsic to public contracts? Few answers in contract theories.

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One possible explanation: Third Party Opportunism (Spiller 2008)

•  “A fundamental difference between private and public contracts is that public contracts are in the public sphere, and thus, although politics is normally not necessary to understand private contracting, it becomes fundamental to understanding public contracting” (page 3)

Public contracts are characterized by the fact that: •  A substantial amount of supervision and control is

done by third parties (such as political contesters and interest groups) … not necessarily interested in the success of the contractual relationship

•  Think of a city mayor contracting out for the provision of public services

Pablo Spiller U. Of Calif. Berkeley

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“Political Contestability” in a Nutshell

•  ... third parties (political opponents, excluded bidders, and interest groups) ... ... not necessarily interested in the success of the contractual relationship

Figure: Monster-in-Law •  Public parties fear for:

-  Third party opportunism prevents the use of relational contracts (Macaulay 1963, Baker & al 2002) for public private contracts

-  Political contestability is an issue for public authorities

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“Political Contestability” in a Nutshell

•  ... third parties (political opponents, excluded bidders, and interest groups) ... ... not necessarily interested in the success of the contractual relationship

CONSEQUENCES : •  Public contracts are (too) more rigid than private ones •  Renegotiations are unavoidable and a sign of “good

cooperation”! •  Especially true when political contestability is high

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Third party’s opportunism – one on-going study on car parks

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III. Parallels with and implications for NPOs?

•  NPOs are contracting with governments: NPOs might be considered as less opportunistic

•  “Nonprofits are deemed particularly valuable for responding to specific service demands that cannot be easily differentiated and satisfied through purely governmental provision”

•  Transaction costs: “For governments, this threat may be reduced when service responsibility is given to non- profit organizations because they are perceived as more trustworthy agents than private vendors, more likely to share public interest goals, and they are monitored by a combination of donors, clients, and government officials” (Richard C. Feiock and Hee Soun Jang, 2009, Public Administration Review”)

•  Trust pre-exist and don’t have to be built•  This “competitive advantage” for NPOs is particularly true for

complex transaction that are not fully contractible.

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Parallels with and implications for NPOs?

• NPOs share characteristics with public entities •  NPOs are publicly accountable

•  They have special “public” benefits such as tax exemptions •  They may have a political agenda which is somehow partisan (e.g.,

Greenpeace may not be the most friendly organization to everybody).

•  Third party opportunism might be a problem •  Relational contracting might be problematic: contractual

inefficiencies must be accepted •  Possible solution: “light” formalism e.g. minutes during

meetings instead of formal amendments

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Wrap up and conclusion

•  Incomplete contracting leads to transaction costs •  Opportunism is an issue •  Reputation based contracts might solve this problem but

are not usable for public contracts – Third Party Oppotunism (TPO)

•  NPOs •  Are more credible than private firms when opportunistic

behaviors is an issue (i.e. complex transactions) •  But need to think carefully of their contractual agreements

in order to cope with TPO. •  When contracting with Gvts•  Or when contracting with private firms

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Stéphane Saussier Saussier@univ-paris1.fr

http://www.webssa.net

Mandel Social Leadership MBA University Ben Gurion

« The specificities of public-private contracting »

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