Reducing risk and leveraging markets: The impact of financial structure on federal contractor performance

This paper analyzes how financial controls, as established through the payment structure, are used and whether they influence federal contractor performance. These payment structures include variants on three primary types of contract: firm fixed-price, cost-reimbursement, and time-and-materials. Each of these payment structures creates different performance incentives for contractors, provides government contract managers with varying levels of information on contractor activities, and alters the dispersion of risk between the partners. The Federal Acquisition Regulation (FAR) prefers fixed-price contracts whenever possible, as they theoretically place the risk on the contractor, who is required to finish the work for the allocated price. Based on an analysis of nearly 25,000 federal definitive contracts that concluded between 2005 and 2014, findings indicate federal contracting officials tend to use payment structures in expected ways: to limit exposure to risk, leverage market forces, and reduce transaction costs when possible. Findings also show that there are important performance differences between contracts that use different financial structures, even when accounting for information asymmetries, asset specificity, and the complexity of the contracted work. Cost-reimbursement contracts are highly correlated with early contract termination.