If You Pay Peanuts …: A Laboratory Experiment on Reward Schemes in Employment Service Contracting

Abstract

The design of tenders and contracts is a crucial factor in the success or failure of the contracting-out of reintegration services. In a laboratory experiment with professionals from private reintegration service providers, we tested two tender designs. In the first design, the government announces a predetermined amount that will be paid for each employment outcome. Participants then bid an amount of money that they are prepared to pay to operate the contract. This auction resembles contracting in the Australian Job Network and the British Employment Zones. The second design is the lowest-reward auction. In this auction, the participants bid a reward. The lowest bid wins the contract, and the reward is then paid for each unit of effort. The lowest-reward auction is similar to the current tendering practice in the Netherlands.

We find that an auction with a fixed reward per placement is more efficient, yields more effort from the winner, and results in higher welfare than an auction in which bidders compete on the basis of the reward per placement. We derive this conclusion from both our theoretical analysis and data from our laboratory experiment with professional bidders.