Good Enough for Government Work? An Incomplete Contracts Approach to the Use of Nonprofits in U.S. Federal Procurement

Abstract

AbstractThis paper examines the use of the nonprofit organizational form to mitigate the impact of incomplete contracts in the public sector Transaction costs economics (TCE) predicts that the expense of incomplete contracts will rise with contract complexity and asset specificity. Previous research shows that government agencies increase their use cost-plus style contracts to economize on these costs. However, cost-plus style contracts may also increase the propensity to inflate procurement costs, also known as gold-plating, when relationally specific investments are required. Consistent with this expectation, we find that federal agencies reduce their use of cost-plus style contracts as asset specificity rises. The paper then explores the use of nonprofit organizations as an alternative tool to reduce contracting costs. Using data from the Federal Procurement Data System, we examine the choice of organizational form by federal agencies, as contracts become more or less incomplete. Consistent with our hypotheses, we find that the use of nonprofit organizations increases with contract complexity. In contrast to cost-plus style contracts, we find that the use of nonprofits also increases with asset specificity. We apply this finding to support the conjecture that the nonprofit organization form is used by government agencies to mitigate contract incompleteness without the associated risk of cost inflation. We conclude by offering suggestions for why nonprofit contracts appear relatively infrequently in federal procurement data.