Moral Hazard, Incentive Contracts and Risk: Evidence from Procurement

Abstract

Deadlines and penalties are widely used to incentivize effort. We model how these incentive contracts affect the work rate and time taken in a procurement setting, characterizing the efficient contract design. Using new micro-level data on Minnesota highway construction contracts that includes day-by-day information on work plans, hours actually worked and delays, we find evidence of moral hazard. As an application, we build an econometric model that endogenizes the work rate, and simulate how different incentive structures affect outcomes and the variance of contractor payments. Accounting for the traffic delays caused by construction, switching to a more efficient design would substantially increase welfare without substantially increasing the risk borne by contractors.