Convertible Procurement Contracts

We study a convertible procurement contract that combines two prevalent fixed-price and cost-plus contracts. After the project begins, the contractor may invest in more accurate cost information that can be further used as evidence to convert his initial fixed-price contract into a cost-plus contract. We find that contract conversion and the associated cost overrun occurs whenever the contractor’s cost distribution is spread-out enough. We also find that despite the presence of both ex-ante and ex-post adverse selection the procurer does not benefit from sequential screening – it is optimal to offer the same static convertible contract to all contractors