The impact of transaction costs in incomplete contracts on prices submitted in the tendering process

Abstract

All contracts are inherently incomplete because although principals and agents agree ex ante to abide by the terms of the contract, their respective investments differ. In anticipation of performance, both recognise incentives for opportunistic behaviour. Investigating the perceptions of both parties in the tender process contributes towards determining what factors can be used by principals and agents to reduce the extent and impact of incomplete contracts, and to minimise their respective transaction costs. The aim of this research is therefore two-fold: firstly, to establish the impact of incomplete contracts and transaction costs on the tendering process, and secondly, to determine what factors can reduce the impact and minimise transaction costs incurred by both parties. The value that both the principal and agent obtain from the tendered work increases in proportion to the quantity or volume of work, and decreases as the agent’s profit and the cost to both parties increase. Therefore, the value that can be obtained subsequent to any contractual transaction reduces as the costs to both parties increase, which includes their production costs and transaction costs. It is clear that the total net benefit in the transaction is increased if the transaction costs of one or both parties can be reduced. The main transaction costs incurred by both parties due to the cost implication of risk and uncertainty, can be summarised as moral hazard and asymmetric information, time delays, search for and disclosure of information, as well as the enforcement and legal costs that both parties may be subjected to.