Eggelston, on Trusting Nonprofits to Do the Right Thing in the Face of Contract Ambiguity

I may owe Professor Eggelston an apology for the headline and the picture but they capture my best understanding, so far, of her recently posted article entitled Reference Points, Nonprofits, and the Scope of Government: Theory and an Application to the Health Sector. How trustworthy are nonprofits in the provision of government contracted public goods and services? And should we assume they will always do the right thing (function optimally) when faced with inevitable ambiguity regarding the contracted goods or services? How much trust does the halo effect justify?  Economist speak a whole ‘nother language, I’ll tell you.  Why can’t they be more like us  lawyers. We always speak perfectly clear American.  Anyway, here is the abstract:

Frictions in contracting relationships are pervasive, especially since initial contracts leave gaps open to interpretation as circumstances change. Yet such ex post contracting frictions are absent in the canonical property rights theory of ownership, which contrasts government in-house provision with investor-owned supply assuming efficient renegotiation. Extending the government “make or buy” decision to nonprofits and ex post frictions based on contracts as reference points suggests that contracting out to a nonprofit can be optimal when “mission” alignment credibly signals adherence to the spirit and not just the letter of the contract in unforeseen contingencies. Contracting out is an imperfect substitute for direct government provision to assure access for populations especially vulnerable to quality shaving. The model allows analysis of ownership differences in the absence of noncontractible ex ante investments while rationalizing differential nonprofit, for-profit, and government provision across the spectrum of services, as illustrated by application to the health sector.

Here  is the paper’s conclusion:

5. Conclusion

Nonprofits supply many tax-financed services like healthcare and education. When governments seek to assure resilient, equitable supply of such services, quality shaving is often an important consideration—and may naturally lead to ex post inefficiency in long-term contractual relationships. Our extension of HSV97 to nonprofits and ex post frictions provides foundations for characterizing the conditions under which government, for-profit, and nonprofit ownership may each be optimal for assuring cost-effective access to a high-quality tax-financed service. By incorporating ex post frictions through the reference point concept of contracts, we also re-introduce competition in ex ante markets as an important consideration as well as avoid the Maskin and Tirole (1999) fundamental critique of incomplete contract theory. Nonprofit provision is efficient when nonprofit “mission” credibly signals adherence to the spirit and not just the letter of the contract in unforeseen contingencies. Many interesting and empirically important extensions are left to future research, including unbundling ownership from incentives, modeling competition ex ante (selective contracting) and ex post (patient sorting) in more detail, and incorporating path dependent evolution of organizational ecosystems.

darryll k. jones