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Incentive Contracting for National Defense: A Problem of Optimal Risk Sharing

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  • J. Michael Cummins

Abstract

This paper analyzes risk sharing in defense contracting within an insurance framework with moral hazard present. The positive model specifies conditions under which risk sharing between the firm and the government can be expected to occur, and identifies the important exogenous characteristics of the firm that determine the equilibrium set of contract terms. An important public policy implication is derived from a normative comparison between the simple incentive structure currently used in defense contracting and a modified contingent claims arrangement. The latter is shown to be superior in providing desirable risk sharing, while also maintaining appropriate marginal incentives for cost control.

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  • J. Michael Cummins, 1977. "Incentive Contracting for National Defense: A Problem of Optimal Risk Sharing," Bell Journal of Economics, The RAND Corporation, vol. 8(1), pages 168-185, Spring.
    • Handle: RePEc:rje:bellje:v:8:y:1977:i:spring:p:168-185
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    Cited by:

    1. Perez-Castrillo, David & Riedinger, Nicolas, 2004. "Auditing cost overrun claims," Journal of Economic Behavior & Organization, Elsevier, vol. 54(2), pages 267-285, June.
    2. Sang-Hyun Kim & Morris A. Cohen & Serguei Netessine, 2007. "Performance Contracting in After-Sales Service Supply Chains," Management Science, INFORMS, vol. 53(12), pages 1843-1858, December.
    3. Bozeman, Dennis P. & Kacmar, K. Michele, 1997. "A Cybernetic Model of Impression Management Processes in Organizations," Organizational Behavior and Human Decision Processes, Elsevier, vol. 69(1), pages 9-30, January.
    4. Rajeev K. Goel, 1995. "Choosing the Sharing Rate for Incentive Contracts," The American Economist, Sage Publications, vol. 39(2), pages 68-72, October.
    5. K. T. Wallenius & N. K. Womer, 1989. "Cost realism in defense contracting," Naval Research Logistics (NRL), John Wiley & Sons, vol. 36(5), pages 533-557, October.

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