Managing Cantract Trevor L.

Performonce: A Transaction ^^'

Costs Appraach

Abstract
Managing contracts is a complex process, often exacerbated by high transaction
costs inherent in negotiating, implementing, and monitoring contract relationships
with vendors. Through analyses of data from a 1997 International City/County
Management Association survey of muincipal and county goveniments, the way in
which municipal and county governments respond to transaction cost factors
inherent in contract service delivery is examined. The results of the analyses
demonstrate that when governments contract for services in contexts that risk con-
tract failure, they engage in a variety of monitoring techniques to improve their
ability to monitor and correct vendor perfonnance. © 2003 by the Association for
Public Policy Analysis and Management.

INTRODUaiON
Government contracting for tbe provision of goods and services is on tbe rise (Greene,
1996). Tbere are many examples of non-profits and private firms working under con-
tract to deliver goods and services that governments once exclusively provided. Yet
research on the success of contracting is mixed (Boyne, 1998; Hirsch, 1995; Lavery,
1999). Conn acting for service delivery involves risks, which if ignored increase the
likelihood of contract failure (Kettl, 1993; Sclar, 2000). One of the ways governments
can respond to these risks is to more effectively monitor vendors' perfonnance—a
costly activity. Effective monitoring may allow governments to capture the benefits of
contr-acting while avoiding its pitfalls (Brown and Bnidney, 1998; Praeger, 1994).
In this paper, a transaction costs framework is used to argue that different risks
under contracting prompt public managers to implement varying monitoring proce-
dures that may improve their ability to evaluate vendor performance. The effects of
various transaction-costs risk factors on governments' contr-act monitoring activities
are investigated through analyses of data from a 1997 International Cily/County
Management Association (ICMA) survey of municipal and county governments.

CONTRAOING RESEARCH

While in-house production remains the primary means through which governments
deliver goods and services (Warner and Hedbon, 2001), contracting witb non-profit,
private, and otber public organizations takes a strong second (Laveiy, 1999), and the
Manuscript received June 2001; oul for review June 2001; review completed January 2002; revision completed July 2002;
revision review compleled September 2002; accepted October 2002.
Journal of Policy Analysis and Management, Vol. 22, No. 2. 275-297 (2003)
© 2003 by the Association for Public Policy Analysis and Management
Published by Wiley Periodicals, Inc. Published online in Wiley InterScience (www.interscience.wiley.com)
DOI: 10.!002/pam.10117
276 / Managing Contract Performance

frequency of contracting continues to increase (Greene, 1996). Governments today

contr-act for educational services, policing, refuse collection, social services, and infor-
mation technology, to name a few (Behn and Kant, 1999). A range of factors influ-
ences the use of contracting as an alternative to in-house production, including fiscal
pressures, annexation restrictions, political forces, bureaucratic routines, and market
conditions (Benton and Menzel, 1992; Car^ver, 1989; Hii-scb, 1991, 1995).
Potential benefits of contracting begin wbere government agencies function as
monopoly service providers and conditions favor external production (Landau,
1969; Niskanen, 1971;Savas, 1987; Weimer and Vining, 1992). Contracting can save
costs by reducing bureaucratic inefficiencies, allowing governments to access
economies of scale, by-passing costly labor and supply requirements, and generat-
ing competition among vendors (Fenis and Graddy, 1991; Mueller, 1989; Ostrom
and Oslrom, 1977; Stein, 1990). Some researcb finds support for tbe efficiency and
cost-savings claims (see, e.g., Miranda and Ler'ner; 1995; Perr^y and Babilsky, 1986).
However, recent reviews of tbe empirical literature suggest tbal tbis suppor-t is at
best mixed (Boyne, 1998; Hirsch, 1995; Lavery, 1999). Beyond cost savings and effi-
ciency, some also ar^gue that outsourcing peripheral functions can improve organi-
zational flexibility and overall perfonnance by allowing managers to focus on core
activities (O'Leary, 1996; Stoker, 1997).
Not all scholarship promotes contracting. Some ar-gue that the customer focus of
the contracting movement conflicts with other tenets of democratic governance,
including citizenship, ci\ic engagement, and broad conceptions of the public interest
(deLeon and Denbardt, 2000). Otbers argue tbat tbe increased complexity inberent in
contracting exacerbates service coordination problems (O'Toole, 1996; Wise, 1990).
Finally, Milwar'd argues tbat contracting leads to a "boUow state" where accountabil-
ity problems are rampanl (Milward, 1996; Milwar^d, Provan, and Else, 1993).
In sbor-1, enougb research bas identified cases of effective contracting tbal few doubt
tbat contracting can improve government performance. Likewise, enougb researcb
bas uncovered cases of failed contracting tbat few doubt tbat contracting risks some
pitfalls. The next step is to better specify tbe conditions under wbicb contracting in
practice fails or beare its promised fntits. A promising line of researcb indicates tbat
tbe nature of tbe good or service under contract and the contr-acting environment
influence contract perforTnance (Stein, 1990). According to Fenis and Gr^addy (1986,
1991), services with r-eadily measurable outcomes and contested mar-kets of potential
vendors tend to successful contracting. Tbe autiiors advance tbis researcb by arguing
thai boundedly rational governments respond to risks under contract by adopting con-
tract oversight and monitoring procedures to reduce the likelihood of contract failure.

TRANSAaiON COSTS AND CONTFUa MONITORING

Coase (1937) and Williamson (1981, 1996) argue that organizations' decisions about
internalizing pr'oduction ("to make it") or externalizing production ("to buy it"
throtigh contracting) reflect the r elative costs of tbe traditional production factors—
fixed assets, labor, and capital—and transaction costs, or tbe "...compai-ative costs of
planning, adapting, and monitoring task completion under alternative governing
structures" (Williamson, 1981, pp. 552-553). Organizations look to optimize across
tbese two types of costs in deciding wbetber to make or buy (Rior^dan and Williamson,
1985). Tbe transaction costs logic can also be applied to governments (Williamson,
1997). Altiiougb governments tend to have more ambiguous goals, complex environ-
ments, and internal constraints tban private firms, tbey are still purposive organiza-
tions that seek to reduce uncertainty risks (e.g., Rainey, 1991, pp. 73-97).
 Managing Contract Performance / 277

When governments can write detailed contracts describing exactly what actions
the vendor should take and what outcomes the vendor should achieve, the risks of
contract failure are low and consequently the transaction costs inherent iti negoti-
ating, implementing, and monitoring a contract relationship are low. In previous
work (Brown and Potoski, 2001), governments have been shown to be more likely
lo contract under less risky circumstances. However, real world complexities and
uncertainties in social interaction often exceed governments' ability to predict
future events, specify contract provisions for all circumstances, and ensure that
actual outcomes match specified objectives. Below, transaction eosts scholarship
was used lo identify three factors—service-specific characteristics, goal incongru-
ence between vendors and the contracting government, and lack of market compe-
tition for the good or service—that put effective contracting at risk.

Service-Specific ChorQcteristics

Williamson (1981) focuses on two broad types of service-specific characteristics—

asset specificity and service measurability. Asset specificity refers to whether spe-
cialized investments are required to produce the service. Specialized investments are
investments that apply to the production of one setA'ice but are very difficult to adapt
for the production of other semces. These specialized investments offer an advan-
tage to the first contract winner, thus creating a banier to enlry and risking market
monopolization. As a result, contracting governments find themselves at a disad-
vantage in negotiating contract tenns in subsequent rounds of bargaining. Service
measurability refers lo how difficult it is for the contracting organization to measure
the outcomes of the service or to monitor the activities required to deliver the set^-
ice. Easily measured services have more readily identifiable performance measures
that accurately represent service quantity and quality. If outcomes are difficult to
operationalize, a service can be easy to measure if it is relatively straightforward to
monitor the activities required to deliver the service. A setrice is difficult to measure
when neither the outcomes to be achieved nor the activities to be performed are eas-
ily identifiable. Under these circumstances, the contracting government is exposed
to the risk of unseen vendor non-performance or negligence (Praeger, 1994).'

Gool Incongruence
A cousin of transaction costs theory, principal-agent theory, argues that the root
problem in situations where principals (in this case governments) direct the behav-
ior of agents (in this case vendors) begins with information asymmetries and goal
incongruence between principals and agents (Miller, 1992). Shirking problems are
exacerbated the more principals have trouble monitoring the quality of agents' per-
formance and executing corrective measures. Some argue that as agents ptivate
firms are more prone to opportunism than mission-driven organizations such as
non-profits and other governments (Light, 2000; Wise, 1990). Private firms may
deliver a lower quality service to reduce their costs and raise profits. For example,

' Williamson also ai-gues that contracting frequency intluences transaction costs. Long-term contracts
can give rise to monopoly as a single vendor comers the market. However, following Williamson (1981)
in his application of this rramework lo internal labor markets, we do not incoiporate frequency of con-
tracting in our sei^vice production classification. We have confidence in our measures of asset specificity
and the ease of measurement. Measuring contract frequency is more difficult because it can vary widely
across communities for the same service.
278 / Managing Contract Performance

in welfare policy, a non-profit may go to great lengths to see that clients are placed
in jobs that pay a living wage, whereas private firms may focus more on meeting
the contract specifications and tberefore stop working with tbe client once be or sbe
is off the welfare r-oles (e.g., Walters, 2000). Even if private firms behave no differ-
ently than otber governments and non-ptofits in practice, contracting gover nments
may still believe private firms are more prone to opportunism.

Non-Compeiitive Morkets
Competitive markets make contracting more effective by providing governments
witb information about tbe trade-offs between price and quality across different
vendors and by disciplining vendors for poor performance (Buchanan, 1971; Peter-
son, 1981). As with asset specificity, governments that contract with monopoly
pr-ovider-s—whether tbey are private firms, otber governments, or non-profits—are
at a disadvantage in negotiating contract terms. Wbile asset specificity results in
monopolization in later rounds of contracting, monopolization can also occur in
the first round. In particular- smaller communities may simply lack competitive
mar'kets for- many public services because of tbeir size.
Wbile contracting in tbe presence of ibese risk factors (service cbaracteristic,
goal incongruence, and non-competitive markets) is less likely, it still occurs
(Brown and Potoski, 2001). In bigher-risk cases, governments can make a variety
of managerial investments to improve tbe cbances of contract success (Br-own and
Potoski, 2003) by reducing vendors' possibilities for opportunism (e.g., Piaeger;
1994). An important question is wbether governments thai contract under risky
conditions engage in tbese costly management activities, or wbetber tbey neglect
oversigbt and inadvertently foster tbe accountability problems forecasted by ibe
"bollow state" literature (e.g., Milward el al., 1993). Following tr'ansaction costs
scbolarsbip in other contexts, tbe autbors believe tbat governments r'espond to
tbese risks and engage in monitoring. However, tbey do so selectively, notably
when investments in monitoting efficiently provides useful information eitber
about vendor perfor mance or behavior.
Governments can monitor contracts through several means (Savas, 2000). Some
monitoring strategies are better suited lo addressing different types of risks associ-
ated with contt-acting. Here tbe focus is on four monitoring procedures tbat gov-
ernments can use to mitigate contract risks—monitoting citizen complaints;
implementing citizen satisfaction surveys; analyzing vendor performance data; and
auditing vendor activities in tbe field.

Monitoring Citizen Complaints

Since citizens are often the direct recipients of contracted goods and services,
they thus have direct knowledge about vendor performance and stronger incen-
tives to report under-periormance. In tbis way, citizens serve as "fire alarms"
(McCubbins and Scbwartz, 1984), calling attention to occasional transgressions
without requiring gover'nments to constantly monitor vendors' activities. Conse-
quently, monitoring citizen complaints can inexpensively deter vendors from vio-
lating contract provisions. In recent years, many municipalities bave formalized
their citizen complaint systems. For example, tbe Par^ks and Recreation Depart-
ment of tbe City of Sunnyvale, California, created a computer database to tr-ack
complaints filed and tbe steps taken to address tbem (Osborne and Plastrik,
2000, p. 370).
 Managing Contract Performance I 279

Implementing Citizen Sotisfoction Surveys

Governments can actively gauge public sentiment about service quality through cit-
izen surveys that provide more systematic and perhaps less biased portraits of ven-
dor performance. For example, the cities of San Diego, California, and Phoenix,
Arizona, conduct periodic satisfaction surveys for specific services to evaluate how
citizens rate the quality of the service overtime (Segal, 2002). On the down-side, cit-
izen satisfaction sui^veys, particularly when administered service-by-sei'vice, can be
quite costly to administer and analyze.

Anolyzing Vendor Performonce Doto

Governments can more directly focus on vendors by auditing and analyzing their
records and performance data. Record audits can be highly effective when the serv-
ice lends itself to easy measurement and the contract clearly specifies outputs and
outcomes. Of course, this requires that public managers have personnel lo organ-
ize the data and sufficient expertise lo analyze and inteipret it. This method places
the burden on the vendor to produce the performance information and can ihere-
fore lead to higher costs for the vendor.

Field Audits of Vendor Activities

Governments can also conduct field audits, a costly way of evaluating vendors,
but one that may require less technical expertise. When governments conduct
field audits—as they often do in regulatory contexts—government employees
physically monitor vendors' delivery of goods and sei*vice.s to recipients. In this
way, governments can gain direct information about service quality, vendor effort,
and citizen satisfaction.
Hence, governments selectively engage in contracting monitoring, depending
on the specific transaction costs (i.e., monitoring expenses) at stake. Fitst, gov-
ernments that contract for more asset-specific services are more likely to adopt
the approach typically used to monitor monopolists—a combination of analyz-
ing vendor records and field audits. Second, the effect of service measurability
on governments' monitoring is more complex: when services are easy to meas-
ure, governments' costly monitoring is not necessary because the information is
easy to acquire. However, governments will use a combination of analyzing ven-
dor records and field audits when contracting for semces that are moderately
difficult to measure. There is likely to be a limit to how well these procedures
work for services that are difficult to measure. When governments contract for
services that pose extreme measurement problems, they are less likely to use
either these behavior-based or performance-based (i.e., citizen sur\'eys and com-
plaint monitoring) techniques because none of these costly activities are likely to
produce the desired information. Thus, little monitoring activity would be
expected when measurement is either very easy or very difficult, but extensive
behavior-based monitoring would be expected when measurement is moderately
difficult. Third, since governments may be more suspicious of private firms'
motives, governments contracting with private firms are more likely to use all
four types of monitoring than when contracting with other governments or non-
profits. Finally, contracting in non-competitive markets is also likely to spur gov-
ernments to use ail of the monitoring techniques to reduce possibilities for
opportunistic vendor behavior.
280 / Managing Contract Performance

Other Monitoring Influences

Other factors may also influence governments' monitoring decisions. In the past, crit-
ics argued that contracting reflects attempts to reduce the role of government rather
than deliver semces more efficiently. Furthennore, because of the fear of layoffs, gov-
emment employees and public employee unions often actively oppose contracting.
The atithoi-s hypothesize that external opposition to contracting, such as opposition
from citizens or elected officials, is more likely to spur governments to conduct mon-
itoring activities that most directly gauge citizen satisfaction—monitoring citizens'
complaints and conducting citizen surveys. Conversely, intemal opposition to con-
tracting, such as from government employees, spurs governments to conduct moni-
toiing activities that more directly gauge vendor perfonnance, such as conducting
field observations. A long-standing recommendation fi-om critics of government oper-
ation and management is that governments stiuctured like pnvate firms ai"e more
likely to behave like private firms, and thus improve piogram efficacy and efficiency.
The council-manager form of government is most directly analogous to the private
firm structure of an appointed CEO beholden to an elected Board of Directors. Fol-
lowing this logic, the authors hypothesize that cotmcil-manager governments are
more likely to engage in all four types of monitoring than other types of goveinment.

METHODS AND DATA

To investigate the influence of these factors on governments' contract monitoring

activities, the 1997 ICMA sui'vey on local governments' alternative service delivery
arrangements was analyzed, along with other data on local govei'nments' organiza-
tion and finances.^ The dependent variables are whether or not each government
engages in each of the four contract-monitoring procedures: monitoring citizen
complaints, implementing citizen satisfaction sun'eys, analyzing vendor perform-
ance data, and auditing vendor activities in the field. The independent variables
measure the different types of transaction-costs risks—asset specificity, service
measurability, goal incongruence, and market competition—inherent in the type of
services governments deliver via contract, plus controls. The statistical techniques
are probit and OLS, wilh an important Heckman selection correction to account for
the fact that not all govemmenls engage in contracting.

Method
Analyses must account for the fact that not all governments engage in contracting, and
those that do not will not condtict any contract monitoring activities. In other woi-ds,
the dependent variables are observed only for governments that contract; presumably

^ The ICMA has heen surveying local and county governments on allemative service delu'ery arrangemenls
every five years since 1982. The survey asks a stratified i^andom sample of local and county govemmenl-s
about which of 64 different seivices they conUTicl for, what types of organizations ihey contract with, and
what capacity investments they have made. The response rate for the 1997 suivey is jusi over 30 jKiLvnt
with 1586 respondents. While this low response i^ale raises the possibility of sample bias, the suney is gen-
erally representative of locaiilit-s and counties along basic criteria like [population, geographic location, and
metropolitan status. The 1997 ICMA sui^vey under-represents local and county governments in the Mid-
Allantic and Southern states, relative to those in Mountain or Pacific Coast slates. As expected, the sample
over-represents council-manager govemments; around 70 peivent of the respondents have this lorni of gov-
ernment. While these biases pose threats to validity, the sti^engths of the sui'vey outweigh ils di.sadvantagcs.
The sut^-ey is the most comprehensive instrument on alternative delivei'y practices of local govemments.
 Managing Contract Performance / 281

some of the governments tbat do not engage in contracting would conduct monitoring
bad tbey decided to contract. Moreover, some of tbe same vatiables (e.g., opposition to
contracting) tbat influence governments' contract decisions may also affect their choices
of monitoring practices if they choose to conti"act. In this context, analyses only of gov-
ernments that engaged in contracting, or of all governments, including those that did
not, would in each case yield biased coefficients. Tbe solution bere is to estimate a two-
stage Heckman selection model, wbere the first stage models whether or not eacb gov-
ernment engages in any contracting, and tbe second stage models wbetber or not tbose
conti-acting goveniments conduct tnonitoring activities (see Green, 1993; Heckman,
1979). More formally, the first and second stages are modeled respectively as

y' = Xi^ + ui (1)

and

.V'" = Zi(f} + Ul (2)

where y'" is the selection dependent variable scored 1 if the government contracts, else
0, and y"' is tbe second-stage dependent variable scored 1 if tbe government engaged
in tbe monitoring activity, else 0. y'" is obseived ifjtj jS + W| > 0. x\ is a vector of selec-
tion equation independent variables and j3 contains tbe corresponding coefficients for
identifying tbe pr-obability tbat a government engages in contracting. Likewise, z\ is a
vector of independent variables, corresponding to 0 coefficients, tbat identifies tbe
probability tbat a government engages in tbe oversigbt activities (y"'). If «i and ui are
correlated, standard pr^obit techniques applied to Equation 2 alone will produce
biased ^ estimates. The Heckman selection technique weigbs tbe y"' by r'esitlts from
Equation 1 to reduce or eliminate tbe biases in (fy lesulting h"om tbe coiTelation
between ti\ and ui. Finally, because v' and tbese measur-es of y'" {monitoring com-
plaints, citizen surveys, vendor audit, and field obsen^ation) are dicbolomous linear sta-
tistical tecbniques sucb as OLS are inappropriate. Tbus probit for tbe first (selection)
state is used, and second probit and OLS for tbe second (monitoring) stages. All esti-
mations were conducted in Stata v6.0 using tbe beckprobit and Heckman commands.

Doto
The method requires specifying the variables (tbe^:; in Equation I) that influence a
government's decisions about wbetber lo engage in any contracting (v'), as well as
tbe variables (tbe Zi in Equation 2) tbat influence a government's decisions about
wbetber to implement tbe contract monitoring procedures (y'")- Tbese analyses
contain two overlapping sets of independent variables for tbe selection equation {xi)
and tbe monitoring equation {zd-^ Because the focus of this paper is on the second
(monitoring) equation, the variables included in this equation are described first.

Contract Monitoring Dependent Variables

Four separate monitoring equations were estimated, one for each of the monitoring
activities (y'") local governments may conduct for managing their external contracts,

^ Note that an independent variable can appear in both equations. For example, lower revenues may
increase the probability thai a government coniracls (perhaps to .save money), but may decrease the
prohahility that a government engages in expensive contract monitoring activities.
282 / Managing Contract Performance

as reported in the ICMA survey. All four monitoring activities were also combined in
an additive index (range 0 to 4). The individual models provide insight into whether
governments are selective about the types of monitoring techniques they use in
response to different factors, while the index shows whether independent variables are
consistent predictoi-s of monitoring. First, monitoring complaints is a dummy vai iable
scored 1 if the government reported that it monitored and tracked the complaints of
citizens to evaluate service deliveiy, else 0. Second, citizen stin'eys is a dummy variable
scored 1 if the govemment reported that it conducted surveys of its citizens to sys-
tematically evaluate service delivery, else 0. Third, vendor audit is a dummy vatiable
scored 1 if the govemment reported that it analyzed data and records to evaluate ven-
dor performance, else 0. Fourth, field observation is a dummy variable scored 1 if the
govemment reported that it conducted field observations to evaluate vendor perform-
ance, else 0. Finally, monitoring index is an index of all four of the dependent vai iabies.*

Controct Monitoring Independent Voriobles

The first transaction costs measures center on service-specific characteristics. Asset
specificity refei"s to whether specialized investments are required to produce the
service. Service measurability refers to how difficult it is for the contracting organ-
ization to measure the outcomes of the service or to monitor the activities required
to deliver the service. To measure these dimensions the authors sent a mail sun'ey
to 75 city managers and mayors asking them to rate the asset specificity and sei-v-
ice measurability of each of 64 services listed in the ICMA survey.^ Respondents
rated each service on two five-point scales with higher values indicating that the
service is more asset specific and more difficult to measure. These ratings were then
averaged across the respondents for each service. The variable asset specificity is the
average rating ior asset specificity for each seiA'ice each government provided via
contract. Likewise, the vatiable service measurability is each govetTiment's average
service measurability rating for services each government provided via contract.
Table 1 reports individual ratings for each of the 64 services.
Governments that contract for more highly asset-specific services are expected to
be more likely to adopt a regulatoiy monitoring regime. For example, respondents
rated the disposal of hazardous materials as highly asset specific (4.22 on the five-
point scale). Governments that contract for this service and others with similar
asset-specificity ratings are likely to engage in vendor audits and field observa-
tions. Governments that contract for difficult-to-measure services—for example,
drug and alcohol treatment programs (4.12 on a five-point scale)—are also more

"* The dependent variables have both strengths and limitations. On Lhe positive side, these four variables
allow us to analyze the use of different types of monitoring techniques in different situations and for dif-
ferent services. On the negative side, the ICMA sur-vey does not provide detailed infonnation aboul the
implementation of these different monitoring techniques. For example, the ICMA does not ask whether
ihese monitoring techniques were implemented annually. Furthermore, the ICMA does not ask about
level of activity; two localities may both audii vendor records, but one locality dedicates five employees
to the task while the other dedicates only one. In spite of these limitations, the dependent variables pro-
vide a rough pix>xy for threshold monitoring activity. From a contract management F>erspective, it is use-
lul to know whether governments engage in monitoring at all and of whai type.
•^ Seventy-five local govemments were randomly selected with two sample slralification criteria—population
and type of govemment (council-manager vei-sus mayor-council). Response rate of 48 percent (36 usable
surveys were returned). The survey instrumenl provided a half-page description of the two service-
specific transaction cost factors—-service measurability and asset specificity. This description mirrors the
definitions we have provided in this paper. The instmment then asked the respondent to rate each of the
64 services included in the ICMA sin-vey on a scale of 1 to 5 for each of these two factors.
 Managing Contract Performance / 280

Table 1. Average asset specificity and service measurability ratings.

A.sset SeiAice Asset Service

Sei-vice Sp)ecificity Measurabiiity Service Specilknty Measurability

Ambulance service 3.61 2.43 Opei^tion of museums 3.59 2.85

Animal control 2.68 2.81 Opei^ation of paiking lots
Building security 2.24 2.17 and garages 2.36 2.03
Buildings and grounds Operation of bus transit
maintenance 2.00 2.20 systems 3.35 2.48
Child welfare programs 3.52 4.08 Operation of para-transit
Collection of delinquent systems 3.50 2.69
processing 2.51 2.08 Operat ion/ma nagenient
Commercial solid waste of hospitals 4.17 3.40
collection 3.06 1.97 Parking meter maintenance
Crime prevention/patiiDl 3.37 3.60 and collection 2.39 2.24
Data pixxressing 3.14 2.6 i Parks and landscaping
Disposal of hazardous maintenance 2.33 2.11
materials 4.22 2.88 Payroll 2.36 1.53
Disposal of sludge 3.52 2.36 Pei^onnel services 2.58 3.31
Drug and alcohol treatment 3.63 4.12 Police/fire communications 3.80 2.59
Electricity utility Prisons/jails 4.04 3.21
management 4.08 2.96 Programs for the eldeily 3.14 3.48
Emergency medical service 3.91 2.76 Public health programs 3.46 3.74
Emergency vehicle fleet Public relations/public
maintenance 3.28 2.11 information 2.65 3.31
Fire prevention/suppression 3.80 3.24 Residential solid waste
Gas utility operation and collection 3.00 2.06
management 4.08 3.00 SanitaiT inspection 3.06 2.57
Heaw equipment vehicle Secretarial serxices 1.75 2.92
Heel maintenance 3.06 2.22 Sewage collection and
Insect/rodent control 2.53 2.63 treatment 4.09 2.36
Inspection/code enforcement 2.91 2.72 Snow plowing/sanding 2.50 2.21
Legal sen'ices 3.39 3.46 Solid waste disposal 3.33 2.12
Maintenance/administration Street repair 2.64 2.40
of cemeteries 2.37 2.41 Street/parking lot cleaning 2.26 2.00
Recreation facility Tax assessing 2.93 2.87
operation/maintenance 2.94 2.61 Tax bill processing 2.31 1.91
Operation of aiiports 4.19 2.96 Title rccords/plat map
Operation of animal shelters 2.80 2.87 maintenance 3.21 2.58
Operation of convention Traffic contixjl/paj king
centers/auditoriu ms 3.58 2.11 enforcement 2.59 2.53
Operation of cultural and Traffic signal installation/
arts programs 3.00 3.26 maintenance 2.91 2.24
Operation of daycare Tree trimming/pianling on
facilities 3.36 3.44 lights of way 2.14 2.36
Operation of homeless Utility building 3.!) 2.50
shelters 3.12 3.42 Utility meter reading 2.32 2.03
Operation of libraries 3.50 2.61 Vehicle towing and storage 2.07 1.97
Operation of mental Water distribution 3.94 2.44
liealth pixjgrams 3.96 4.29 Water treatment 4.12 2.36
284 / Managing Contract Performance

likely to use behavior-based monitoring techniques, namely vendor audits and field
observation. However, since there may be a limit to how well these procedures can
compensate for difficult-to-measure semces, the analyses also include the square of
the seivice measurability variable. A nonlinear relationship is expected where the
likelihood of utilizing these monitoring techniques increases as service measttrability
moves from easy (1 or 2 on the 5-point scale), to moderately difficult to measure
(3 on the 5-point scale), and then ultimately decreases as se}~vice meastirability moves
to very difficult to measure (4 or 5 on the 5-point scale).
We measure the potential for more principal-agent problems with the proportion
of government services provided through contracts that are contracted with for-
profit vendors. This variable is called for-profit vendors. Unlike non-profit organiza-
tions and other govemments, for-profit firms may have different motives for
contracting with govemments. Even if there are no behavioral differences between
these different types of organizations in practice, the authors suspect that govem-
ments believe there is a difference because of goal incongruence. The expectation is
that governments that contract more with for-profit vendoi-s will conduct more of
each of the four types of monitoring.
A rudimentai7 proxy is used to measure market competition—the population of
governments'jurisdiction as reported in the 1990 U.S. Census. Larger populations
are assumed to be more likely to have more competitive service markets. The argu-
ment is that as market competition decreases, govetnments are more likely to adopt
monitoring procedures. Other scholarship finds that population has nonlinear rela-
tionships with government contracting activities (e.g.. Stein, 1990). Monitoring
contracted services may not require extensive formal monitoring procedures in very
small communities with fewer than 30,000 to 50,000 people because public man-
agers can simply observe vendor performance through informal channels. In such
circumstances, effective informal monitoring can tiximp the disadvantages of
uncompetitive markets. Medium-sized communities may be doubly cursed: they
are too small to contain robust competitive markets, yet they are too large for effec-
tive informal contract monitoring. As population increases fr'om medium to large,
competitive markets replace formal monitoring piocedures as effective checks on
vendor perfonnance, thus mitigating the need for formal monitoring procedures.
To investigate this, the analyses also include the square of the population variable.
These variables are labeled population and population-, respectively.
Also included are several control variables in addition to transaction cost measures.
To begin, political conflict can exacerbate principal-agent problems and thus spur the
need for mot-e contract monitoring. This conflict is measured in two ways. First, exter-
nal conflict is a dummy variable scored I if during contracting an-angements govern-
ments experienced opposition from citizens or elected officials, else 0. Second,
internal conflict is a dummy variable scored I if during contracting aixangements gov-
emments experienced opposition from department heads or line employees, else 0.
Govemments that experience external conflict about contracting are more likely to
monitor citizen complaints and conduct citizen surveys. Govemments that experi-
ence intemal contracting conflict are more likely to monitor vendor performance by
field obsen/ations in order to prevent problems that may fuel future opposition.
Governments' stmcture and capacity may also affect their decisions about mon-
itoring contracts. Governments with more professional management structures,
that is those with council-manager forms of government, should be more likely to
monitor contracts. Consequently, the analyses include a dummy variable, cotmcil-
nianager, scored 1 if the govemment is a council-manager form of government,
else 0. Govemments with robust fiscal resources should be better able to afford
 Managing Contract Performance I 285

contract-monitoring procedures. The variable revenues is operational zed as overall

general revenue per capita, as reported in the 1997 Census of Governments. Finally,
county governments are controlled for with a dummy variable, county, scored 1 if
the government is a county govemment, else 0.

Seleaion Equotlon Dependent Variable

Recall that the primary purpose of the selection equation is to reduce or eliminate
selection bias in lhe monitoring equations that result from the fact ihat not all gov-
emments engage in contracting. Govemments may conlract with a variety of ven-
dors, including for-profit firms, non-profit organizations, and other governments.
Contracting (y') is scored 1 if a government contracts with any of these extemal ven-
dors (for-profit, non-profit, or other government) for at least one service.

Selection Equation Independent Variables

The primary' goal with the selection equation is to identify a slate of independent vari-
ables that explains why some governments engage in contracting while others do not.
While not central to this inquiry, a properly specified first-stage equation can still pro-
duce theoretically interesting results while reducing biases in the second-stage (mon-
itoring) equations. To properly specify this model the authors consulted the literature
on the contract decision and follow the earlier discussion about factors that influence
govemment's service deliver>' choices, including fiscal pressures, annexation restric-
tions, political forces, bureaucratic routines, and market conditions.
Local govemments under significant fiscal stress—particularly those with low
revenue capacity and in states that impose property tax limitations—often use con-
tract service provision to reduce semce delivery costs (Fetris, 1986; Hirsch, 1991,
1995). Two measures of fiscal constraints are included. First, the selection equation
includes the revenues measure; governments with lower pei" capita revenues may
have stronger incentives to engage in contracting. Because tax limitations may com-
pel governments to contract service production to save costs, the dummy variable
tax limitation is included and scored I if the local govemment is in a state that lim-
its local governments' ability to tax property. Those local governments in states wiih
tax limitations are expected to be more likely to engage in contracting.
Similarly, growing communities in states that limit annexation often contract for
services fi'om neighboring govetnments because they cannot expropriate those
Jurisdictions into their own (Slein, 1990). Here, Hill's (1978, 1993) data are used to
perform factor analysis on six dimensions of annexalion aulliority lo create an
annexation scale, ranging from least restrictive to most restrictive, with a mean of
0 and a standard deviation of 1. This variable is called annexation limitation. As
annexation limitation increases governments are expected to be more likely to
engage in contracting. As was the case with contract monitoring, governments'
structutes are likely to influence their decision to conlract. Because the council-
manager form of govemment is the closest analog to private corporate structure in
the public sector, the variable council-manager is included in the selection equation.
The initial expectation is that having this form of government will increase the like-
lihood of contracting, since out-sourcing is a common management reform pro-
moted within the council-manager community.
The political environment is also likely to be influential; strong poHtical opposition
can diminish the likelihood that a local govemment will conlract even when fiscal stress
is high {Fenis, 1986; Hii-sch, 1991, 1995; Thompson and Elling, 2000). On the other
286 / Managing Contrfict Performance

hand, those governments that do contract may generate more conflict. Consequently,
the analyses include both the conflict measures included in the monitoting equation,
external coujJict and internal conflict. Another environmental factor likely to influence
the contracting decision is the condition of the market loi- public scn'ices (Sclai; 2000);
kxral govcinments located in densely populated metiopolilan aieas are more likely to
have opportunities to pui-sue contracted service pixjvision than local govemments in
spar-sely populated rural communities (Stein, 1990). Therefore, several contmls are
included to gauge the eifcct of local context, including population, popidation^, cotmty
government. and metropolitan area. Metropolitan area is a dutnmy variable scored 1 if
the govemment is located within a U.S. Census Bureau metropolitan statistical area,
else 0. Finally, providing mot-e goods and services expands the opportunities to conlract
for the delivei'y of at leasl one. Consequently, a control variable, total sendees provided.
is incltided as a count of the number of services each govemment pi'ovides. Table 2 pro-
vides the descriptive statistics foi' all the variables in these analyses.
In the analyses below, the variables in the seiection equation (x, in Equation 1) are:

1. revenues;
2. property tax limitation;
3. annexation limitation;
4. council-manager;
5. external opposition;
6. internal opposition;
7. population, poptdation^;
8. county;
9. metropolitan area; and,
10. total services provided.
The variables in the second-stage monitoring equation (the zi in Equation 2) are:
Transaction Costs Variables:
1. asset specificity;
2. service nieasttrability, service measurability^;
3. for-profit vendors;
4. poptilation, poptdation^;
Controls:
5. extemal opposition;
6. internal opposition;
1. comtcil-manager;
8. revenues; and
9. county.

RESULTS
Overall, lhe results indicate that transaction-costs risk factors play an important role
in governments' contract monitoring decisions and lhe effects of different contract
risks vary across the four monitoring activities. Table 3 reports the results of five
Heckman analyses for each of the monitoring equation dependent variables, moni-
tor complaitits, citizen surveys, vendor audit, field obsetvation. and monitorijig index.
The nonlinear specification of probit models complicates intet-pretation. One
common solution is to repoil lhe predicted probabilities that tesult from changes
 Managing Contract Performance I 287

i!
O O O O O

p. j£
»N — o r-i o ^
lO r^. r^ in — o^ — ^
Tf rr, TT Tt f^ ' • — u G
o o o o d ^ Jii o d d d d •S E

a r
in O r j 1/1 lO OO r*l h-
O "N f i 00 -O <N i n o •* — (MO
+ — fV| rt •<r r - -^
(N f-:
d a
r*^ '— m r^ ^ f*i in
odd '^ « I^
d d d d d o 00
d d
o o -c o

>^ >. >. y I %

3 3

s
( J CJ

O 0 0 O 'E II
-a
o

.5 .= .£ .S

ax:

(Ji

o ^ n
rab

rab

-g-s 3 3
••9
'S
IS
a
•c a
_. o s O
•a £-3
o u
u > u- S UJ ^ 5I
288 / Managing Contract Performance

lid

- 5
^ ~" ^ 'n U-J MJ O*' O IN CJ O ro fN nj ^ O r^ m LU UJ ro fN rn ^ Q
in 00 1^ (N r*^ <^ o^ 0\ CO in ^^ in *^ m fN m m in ^^ r^ r^ in /^ r^ o^
>—ir^*—'•—it^oo o o o d ^ - * — o o o o o o r o ^ o o o ^ - o
O O O O ^ < N OOOOO-"" O O O O O P ' ^ ' - ^ O O O d O
* * - « *
*.. * * * .£9
*'T7 * . * « * . « * p ' 7 * * «
' ^ ^ ^ l O O ^ ^ - r^*-'-—'fSd—^ ^^QOOOr^oO — f M O ^ f O r v j . C O ^ i n r o
r*JPfN^r*l\O •~*<NinOOro ' - ^ f N P P ^ ^ ^ O ^ f ^ P ^ ^ O ^ ^ O O ' — •
o*—*por^oo o p o o o ^ p o o p p o o o ^ p o o — * p ^ i n
I I II 11 IT iTiN-^

— O -C 00 UJ UJ
00 fN O (^ — -O
C ^ O •o p p p — <N
p p p p —; —; O O O O O
-^ d d d d d
d d d d d r^

a o o — 'I- O O O O O - t O p
-a
-S

— ^<N--;fOrO O p O p — f^ d O O O O O > O r ^ O O O — f^l

o — ppin(N d d d d d " d d d d d d r n — ^ d d d d d
* * « *
* * * «
•^ \n * t* ih LQ 5 I * * * * * * * * * I. I * * * * *
^r ' ^ ^" ^^ i n oc .—I ^1 ^ ' • 'CT^^~^ ^^ [^ CJ o o oo ^~ 'O ^^ "^" ^^ ^& i n ~^ r**. o^
r*.jCT\^^ m ^" i n
d — ddr-iod
L ^ ^^ r o ^^ •." .^—•
d d d d d 't
»—' r o .—• ^—^ ^™ "^^ c ^.o c ? ^3 ^^ r o r^*. ^^ i n
d d d d d d ' — ir', ddd-^d'xr~^ .s
t 1 IT T T I T I I -o
J^ ro r-- ro
p
^7 7 -;
L ', ro II

O O O O O <N — O O O O O

u i N r O
— IN —
CJ ^P
d d d d d—
—^-T d d d o d

o —
— oo •^ i n Uj UJ O — —
oo vO — r o O 00 O O a^ m (N ro mm —r - r ^ i n p — m
-- — r-1 — eo in p p p P — •«
d d d d d '^ d d d d d d r n — d d d d d

\O ro t~~ rn
: ?7 ?7
'2 t= in o —' 00 UJ tiJ
O — r^l O — oo
— n-1 •O >D — r ^
f*i (N 00 r-i t^ O <N p T T O p 00 1 r^ i-o
p -- p 't in ro d d t~^ -rr d d d
c d d d d — JD d dddd o ?
ni
<u 0 C
« •3 o
•c
ffl n O Si £
1 1^ ~ 'I .5
25 c c
< CL

I 8
"5 =
<*? CO O o oo
u .0 - ;
Q. §§ 2 -^ P S. Si
3 B ol d^
E2 ^ 5= ^
 Managing Contract Performance I 289

Table 4. Predicted effects of independent variables on contract monitoring activities.

Independent Variables Monitor Citizen Vendor Field
Complaints Surveys Audit Obsei-vation
Monitoring Activities Equation
Asset Specificity — — 0.05 0.07
For-profit Vendors 0.15 — 0.19 0.14
Controls
External Opposition 0.08 0.05 — —
Internal Opposition — 0.05 0.05 0.07
Council-Manager 0.16 0.08 0.15 0.16
Revenues — — —
County — — 0.07 —

Cell entries are predicted effects (as defined in text), calculated from Table 2.

in each independent variable when all other variables are held at their mean (Long,
1997). The predicted effect of an independent variable is the simulated change in
probability (positive or negative) associated with a change in the independent van-
able from one standard deviation below its mean to one standard deviation above,
holding all other independent variables at their mean. The predicted effect of a
dummy variable is the simulated change in probability (positive or negative) asso-
ciated with a change in the independent vaiiable from a value of 0 to a value of 1,
holding ail other independent variables constant. Table 4 presents the predicted
effects of all the significant non-squared term variables on investments in each of
the four types of monitoring. For the more complicated independent variables,
where the squared term reflects underlying nonlinearities {service measurability,
population), the predicted probability of engaging in the relevant monitoring activ-
ity is plotted across the range of the independent variables. These figures are pre-
sented (Figures 1 and 2) for two variables for just one of the monitoiing
equations—field observations.*

Monitoring Equafion: Service-Specific Chorocteristics

Each specific transaction-costs risk factor is discussed in tum. Firet, an increase in
asset specificity increases the likelihood that governments engage in direct monitor-
ing of vendor performance (through auditing vendor records and conducting field
inspections). As shown in Table 2, the coefficient {ovasset specificity is statistically sig-
nificant and positive in the field audit equation (column 8) and approaches signifi-
cance in \hG vendor audit equation (column 6), but not in the monitoring complaints
(column 2) and the citizen surveys (column 4) analyses. More specifically, increasing
the degree of asset specificity in contracted services increases the probability of
engaging in vendor audits and field observations by 0.05 and 0.07, respectively.
The coefficients for service measurability and service measurability^ are jointly sta-
tistically significant in the vendor audit and fteld audit analyses, as well as the mon-
itoring index analysis. The service measurability coefficients are positive while the

* The squared term variables are also jointly significant in other equations. However, due to space con-
straints we only present the predicted probability plots for tbis particular monitoring equation. In these
other instances, we note when ihe variables are significant and discuss the character of their influence
on the dependent variable in (he text.
290 / Managing Contract Perfonnance

0.3

0 1

0.05

Eose of Measurement

Figure 1. Predicted probability of conducting field observations by ease of measurement.

service measurability^ coefficients are negative, suggesting a significantly cui^ved

relalionship between contracted services that are difficult to measure and the prob-
abilily ihat a government engages in vendor and field audits. Figure 1 depicts this
relationship between service measurability and the probability that governments
conduct field observations. The Y-a.xis gauges the probability of engaging in Held
obsei-vations (holding all other independent variables at their means), and the X-axis
shows the range of the independent vatiable {ser\>ice measurability) from low {easy
measurement) to high (difficult measurement). As Figure 1 indicates, the probabil-
ity of engaging in field ob.sei-vations increases significantly moving from easily meas-
ured services to moderately difficult-to-measure sei-vices. To provide a sense of scale,
increasing sennce measurability from its minimum to its tnean increases the proba-
bility ol conducting field obseivations by 0.08. Once sennce measurabiliiv inci'eases
beyond its mean (about 2.7). the piobability that a govei'nment conducts field obser-
vations declines. While not depicted graphically, a similar pattern is present for the
probability of conducting vendor audits as service measurability increases. Increas-
ing ^en'/ce mea.-ittnibility fiom ils minimum to its mean increases the probability of
conducting vendor audits by 0.10; increasing ser\nce meastmibility from its mean to
its maximum decreases ihe probability of conducting vendor audits by 0.33.
Viewed togethet; the results for the variables asset specificity and service measur-
ability suggest that governments respond to these service-specific characteristics by
engaging in behavior-based monitoiing techniques. When measuring performance
outcomes becomes slightly more difficult, govei nments turn to tools—natnely ven-
dor audits and field observations—that allow them to assess the activities vendors
are performing. However, when measuring services becomes extremely difficult, the
use of these monitoring techniques diminishes.
Asset specificity appears to have a more limited effect. While the variable
approaches significance in the case of vendor audits, it is only significant for field
 Managing Contract Performance / 291

0.7-

0-6

5 0 5-

^ 0.4

^ 0.3-

0 2-

0.1 •

0 •

Populotion

Figure 2. Predicted probability of conducting field observations by population.

observations. As asset specificity increases, the probability that governments use

field observations increases. Williamson (1996) contends that asset specificity is the
most dangerous factor in terms of driving contract failure because of the propen-
sity for monopolization. The results described here provide only limited support for
this claim. The authors' interpretation is that, as Williamson argues, assessing flsse?
specificity will vary substantively from contract to contract. The measure may be
unable to gauge such underlying variations within each service contract. Future
research should seek out more nuanced measures of asset specificity.

Monitoring Equotion: Gool Incongruence

The results indicate that governments increase their monitoring activities the more
they contract with for-profit vendoi's. As shown in Table 3, the coefficient ior for-
profit vendors is significant and positive in three of the fom- individual monitoring
equations—monitor complaints, vendor audit, and field obseivation—with respective
predicted effects of 0.15, 0.19, and 0.14 (see Table 3). In addition, the variable is sig-
nificant in the monitoring index equation. In other words, governments that utilize
for-profit vendors (as opposed to contracting with non-profits and other govern-
ments) for a high percentage of their contracts adopt more monitoring procedures.
This finding is consistent with our expectations that governments inciease their
monitoring activities when they contract with for-profit vendors, perhaps due to
perceived or real goal incongiuence between the vendor and the contracting gov-
ernment. What is not clear from these results is whether goal incongruence pro-
vides reasonable grounds for heightened vigilance. Findings do not indicate
whether for-profit vendors are in fact more likely to behave opportunistically than
non-profit vendors or other governments.
292 / Managing Contract Performance

Monitoring Equotion: Non-Competitive Morkets

Governments are also very responsive to local market contexts when making deci-
sions about monitoring contracts. As shown in Table 3, the population coefficients
are positive while the population^ coefficients are negative actoss all four types of
monitoring as well as the index, suggesting a significantly curved relationship
between the population and the probability that a government engages in monitor-
ing. Figure 3 shows this relationship graphically for conducting field observations.
The probability of conducting field obsei-vations increases significantly moving
from low-population governments to medium-sized communities and then declines
moving to very large communities. Governments in highly populated jurisdictions
conduct fewer field observations than those with medium-sized populations. To
provide a sense of scale, increasing population from its minimum to its mean
increases the probability of conducting field observations by 0.29. An increase in
population from its mean to its maximum decreases the probability of conducting
field observations by 0.44. Poptdation exhibits similar relationships across al! three
of the other monitoring procedures.
The results from the four monitoiing equations provide some support for the
hypothesis about the effect of non-competitive markets. One explanation of these
results is that small communities do not need to adopt formal monitoring proce-
dures because they can rely on informal channels to monitor contract performance.
Similarly large communities can forego the use of monitoring procedures because
they can rely mote on the market to both pressure vendors to adhere to contract
provisions (for fear a competitor wins future contract rounds) and pt ovide the con-
tracting government comparative price and quality infonnation. Medium-sized
communities, however, may be too big to rely on informal channels and too small
to benefit from a dense market place. Instead, these communities ttirn to a variety
of monitoring techniques to police vendors.
An alternative explanation is that the transaction costs of monitoring in large
communities—where vendors operate over a large geographic area and
population—may be so high that there are diseconomies of scale in monitoring.
Consequently, an absence of monitoring in large communities may be a result of the
high costs of monitoring in these circumstances rather than any benefits associated
with more competition.^ Unfortunately, the roughness of the measure does not
allow us to differentiation between the two potential explanations.

Monitoring Equotion: Control Voriobles

In addition to the primaiy focus on transaction-costs risk factoi-s, these monitor-
ing equation analyses include several control variables of some potential interest.
PoMtical conflict over contracting can spur governments to conduct more contract
monitoring activities, although the effect of such conflict varies somewhat by type
of monitoring activity and whether the source of the conflict is internal or exter-
nal. Governments respond to external conflict by focusing on the effects of con-
tracted services on citizens. Thus, in the Table 3 analyses, external conflict
increases the probability that a government monitors citizen complaints by 0.08
and implements citizen suiveys by 0.05. Conversely, governments respond to inter-
nal conflict largely by increasing their direct monitoring of vendor behaviors. In
the Table 3 results, intemal conflict increases the probability that a government

' We thank one of ihe anonymous reviewers for this insight.

 Managing Contract Perfonnance / 293

implements citizen surveys by 0.05, conducts vendor audits by 0.05, and conducts
field observations by 0.07. Council-manager governments are more likely to
engage in all four types of contracting activities, providing some support for the
notion that governments with this form have higher capacity and may be more
attuned to the dangers of contracting than other forms of government. County gov-
ernments are no more or less likely to engage in contract monitoring, and some-
what surprisingly, governments with higher per capita revenues are no more likely
to engage in contract monitoring.

Selection Equotion
Several results from the selection equation analysis are worth noting." Fiscal resources
and pressures impact governments' decisions to engage in contracting. Govern-
ments with fewer revenues per capita and in states that limit their tax and annexa-
tion authority are more likely to contract than wealthier governments in states that
do not limit tax and annexation authority. Other factors that increase the probabil-
ity that governments contract include governments that provide more sei-vices via
contract and intemal conflict. On the other hand, council-manager governments
and governments that face external opposition to contract are less iikely to engage
in contracting. The effect of population varies. At lower levels, increasing popula-
tion raises the probability that a government engages in contracting. However, at
higher levels, increasing population lowers the probability that a government
engages in contracting.

CONCLUSION

Research on the "hollow state" has raised concerns about the ability of governments
to manage service provision under contract (see, e.g., Milward and Provan, 2000).
This concem may be well placed since contracting poses a new set of risks to suc-
cessful service deliveiy, risks that call for new management capacities (Kelman,
1990, 2001; Wise, 1997). This paper presents a novel means for recognizing risks to
contracting success. Using transaction costs theory, three categories of risks are
identified—those associated with the type of service being contracted, the ctintract
partner, and the market context of the contract. Govemments that recn;;iii/c and
mitigate these risks can then take appropriate steps to reduce the chancx's of con-
ttact failure, notably by adopting contract monitoiing procedures. While previous
research demonstrates that monitoring vendor behavior and performance can
improve the chances of successful contracting (Behn and Kant, 1999; Pt*aeget-,
1994), other evidence suggests that govemments sometimes shirk their contract
oversight responsibihties (see, e.g.. Brown and Btoidney, J998). In addilion to iden-
tifying threats to contract success, our results also help explain why governments
sometimes invest in contract monitoring procedures to address these threats, but
other times do not.
All in all. the empirical results discussed here provide evidence that govemments
establish monitoring procedures partly in response to transaction-costs risk
factors inherent in the services and the contracting environment in which they are
delivered. For example, when govemments contract for highly asset-specific

** The f} coefficient and the likelihood ralio test for independent equations are both significant across all
analyses, suggesting that the monitoring equation results would otherwise be biased. Our selection cor-
rections arc iustilied.
294 / Managing Contract Performance

services, they are more likely to engage in field obsei-vations of vendor activities.
The results also suggest that governments are to some extent selective about the
types of monitoring procedures they employ under different conditions. The
authors believe this is because governments weigh the transaction costs associ-
ated with different types of monitoring versus the information they expect to gain
on vendor performance and behavior. For example, as vendor performance
becomes more difficult to measure, governments increase their use of vendor
audits and field obsei-vations in an effort to gather information about vendor
behavior. However, the use of these monitoring procedures declines for very diffi-
cult to measure services, when neither performance nor behavior can be gauged
with much accuracy.
In addition to unease about the types of services governments contract for,
some analysts are also concerned about the types of organizations governments
are contracting with—notably for-profit firms (see, e.g.. Light, 2000). Findings
suggest that governments are more cautious when there is potentially more goal
incongruence between themselves and vendors. Specifically, governments that
contract more with a higher proportion of for-profit vendors (as opposed to non-
pt ofits or other governments) are more likely to monitor citizen complaints, con-
duct field observations, and audit vendors. Apparently governments are more
trusting when contracting with mission-driven non-profits and other govern-
ments than with for-profit providers. Results presented here also provide some
insight into the role environmental conditions play in the decision to monitor
under contract. In particular; governments in very large jurisdictions conduct
fewer monitoring activities than governments in medium-sized jurisdictions,
where the most monitoring is done. One interpretation is that a vigorous market
of potential vendors—measured here by population size—can reduce the need for
these monitoring procedures. Alternatively, the transaction costs of monitoring in
large communities may be so high that goveniments chose not to incur the mon-
itoring costs when they contract. Because of data limitations, future research
using more direct measures of market competitiveness is needed to sort out
which explanation is more accurate.
Overall, the findings suggest some tentative clues about why contracting is
sometimes successful and sometimes not. Governments are responsive to con-
tract risks, but only to a degree. Monitoring is a costly activity. If governments are
unlikely to reap information that allows them to better police vendors, they may
decide not to incur the monitoring costs. Under these circumstances, risks to con-
tract failure remain high. In addition, govemments are more vigilant when they
contract with vendors who they fear are more prone to opportunism—for-profit
firms. Future research should investigate whether monitoring procedures, like
those discussed here, and other contract management techniques are effective at
reducing the risks associated with contracting. The authors offer two suggestions
for proceeding on this agenda. First, scholars should study contract outcomes in
order to identify why and when different service delivery approaches work better
than others. For example, research could explore whether the particular types of
monitoring procedures discussed in this paper increase contract success. Second,
lutuie research might be better sen/ed by focusing on services rather than gov-
emments as the unit of analysis. Such research could focus on how governments
choose to deliver specific services, what specific monitoring approaches they
adopt for those services, and how sen/ice delivery and monitoring affect sei^vice
outcomes. This would allow comparisons both within govemments across
services and across govemments within services.
 Managing Contract Performance / 295

Tbe autbors would like to tbank David van Slyke and tbe anonymous reviewers at JPAM for
tbeir insigbtful comments on previous drafts. An earlier version of tbis paper was presented
at tbe annual meetings of tbe Association of Public Policy Analysis and Managemeni, Wash-
ington, DC, November 2001.

TREVOR L. BROWN is an Assistant Professor at the School of Public Policy and

Management, The Ohio State University, Columbus.

MATTHEW POTOSKI is an Assistant Professor, Department of Political Science, Iowa

State University, Ames.

REFERENCES

ACIR lAdvisory Commission on Intergovernmental Relations]. (1995). Tax and expendi-

luie limits on local governments. Indiana University: Center for Urban Policy and tbe
Environment.
Bcbn. R., 6i Kant. P. (1999). Strategies for avoiding tbe pitfalls of performance contracting.
Public Productivity and Management Review, 22, 470-489.
Benton, J., & Menzel, D. (1992). Contracting and franchising: County services in Florida.
Urban Affaii's Quarterly, 27. 436^56.
Boyne, G.A. (1998). Bureaucratic theory meets reality: Public choice and service contracting
in U.S. local government. Public Administration Review, 58(6), 474-484.
Brown, M.M.. & Brudney, J.L. (1998). A "smarter, better, faster, and cbeaper" government:
Contracting and geographic information systems. Public Administration Review. 58(4),
335-345,
Brown, T., & Potoski, M. (2001). Tbe influence of transaction costs on government service
production decisions. Presented at tbe 6tb National Public Management Researcb Confer-
ence. Indiana University, October.
Brown, T, & Potoski, M. (2003). Contract management capacity in municipal and county
govemments. Public Administration Review, 63(2). 136-147.
Bucbanan. J. (1971). Principles of urban fiscal strategy. Public Choice. 4. 1-16.
Carver, R. (1989). Examining tbe premises of contracting out. Public Productivity and Man-
agement Review, 8, 27-40.
Coase. R. (1937). Tbe nature of tbe firm. Economica, 4. 386-405.
deLeon, L., & Denhardt, R.A. (2000). Tbe political theory of reinvention. Public Administra-
tion Review, 60(2), 89-97.
Fenis, J.M. (1986). The decision to contract out: An empirical analysis. Urban Affairs Quar-
terly. 22(2). 289-311.
Fenis. J.M., & Graddy. E. (1986). Contracting out: For what? With whom? Public Adminis-
tration Review, 46(4), 332-344.
Ferris, J.M., & Gtaddy, E. (1991). Production costs, transaction costs, and local government
contractor choice. Economic Inquiry. 24(July). 541-554.
Green, W.H. (1993). Econometric analysis (2nd ed.). Engiewood Cliffs. NJ: Prentice Hall.
Greene. J. (1996). How mucb privatization? A research note examining tbe use of privatiza-
tion by cities in 1982 and 1992. Policy Studies Journal. 24(4), 632-640.
Heckman, J. (1979). Sample selection bias as a specification error. Econometrica, 47,
153-161.
Hill, M. (1978). State laws governing local government structure and administration (1st ed.).
Atbens: Univei^sity of Georgia Institute of Government.
296 / Managing Contract Performance

Hill, M. (1993). State laws governing local government structure and administration (2nd
ed.). Wasbington, DC: U.S. AdvisoiT Commission on Intergovernmental Relations.
Hirsch, W.Z. (1991). Privatizing government services: An economic analysis of contracting
out by local governments. Los Angeles: Institute of Industrial ReUiIions.
Hirscb, W.Z. (1995). Contracting out by urban governments: A review. Urban Affairs Review,
30(3), 458^72.
Kelman, S. (1990). Procurement and public management: Tbe fear of discretion and tbe
quality of public performance. Washington, DC: AEl Press.
Kelman, S. (2001). Contracting. In Salamon (Ed.), Tbe tools of government: A guide to tbe
new governance (pp. 282-318). New York: Oxford University Press.
Kettl, D.F. (1993). Sharing power: Public governance and private markets. Wasbington, DC:
The Brookings Institution.
Landau, M. (1969). Redundancy, rationality, and the problem of duplication and overlap.
Public Administration Review, 39(6), 346^358.
Lavery, K. (1999). Smart contracting for local government services: Processes and experi-
ence. Westport. CT: Praeger.
Light, P. (2000). Making nonprofits work: A report on tbe tides of nonprofit management
refotm. Wasbington, DC: Brookings Institution Press.
Long, J.S. (1997). Regression models for categorical and limited dependent variables. Thou-
sand Qaks, CA: Sage.
McCubbins, M., & Scbwartz, T. (1984). Congressional oversight overlooked: Police patrols
versus fire alarms. American Journal of Political Science. 28, 165-179.
Miller. G. (1992). Managerial dilemmas: Tbe political economy of hierarchy. New York: Cam-
bridge University Press.
Milward, H.B. (1996). Symposium on tbe hollow state: Capacity, control and performance in
interorganizational settings. Joumai of Public Administration Research and Theory, 6(2),
193-195.
Milward. H.B., & Provan, K. (2000). Governing the bollow state. Joumai of Public Adminis-
tration Researcb and Tbeory, 10, 359-379.
Milward, H.B., Provan. K.G., & Else, B.A. (1993). What does tbe hollow state look like? In
Bozeman (Ed.), Public management: The state of tbe field (pp. 307-322). San Francisco:
Jossey-Bass.
Miranda, R., & Lerner. A. (1995). Bureaucracy, organizational redundancy, and the privati-
zation of public services. Public Administration Review, 55(2), 193-200.
Mueller, D. (1989). Public choice II. Cambridge: Cambridge University Press.
Niskanen, W.A. (1971). Buttaucracy and representative government. Chicago: Aldine Atberton.
Q'Leary, R. (1996). Managing contracts and grants. In Perry (Ed.), The handbook of public
administration (pp. 263-275). San Francisco: Jossey-Bass.
Qsbome. D., & Plastrik. P. (2000). Tbe reinventor's fieidbook. San Francisco: Jossey-Bass.
Qstrom. E., & Ostrom, V. (1977). Public goods and public choices. In Savas (Ed.). Alterna-
tives for delivering public services (pp. 7-49). Boulder. CO: Westview Press.
QToole, L.J. (1996). Implementing public programs. In PeiTy (Ed.), Tbe handbook of public
administration (pp. 250-262). San Francisco: Jossey-Bass.
Perry, J.L., & Babitsky, T. (1986). Comparative performance in urban bus transit: Assessing
privatization strategies. Public Administration Review, 46(1), 57-66.
Peterson, P. (1981). City limits. Chicago: University of Chicago Press.
Pi-aeger, J. (1994). Contracting out government services: Lessons from the private sectoi;
Public Administration Review, 54(2), 176-184.
 Managing Contract Performance I 297

Rainey, H. (1991). Understanding and managing public organizations. San Francisco:

Jossey-Bass.
Riordan, M., & Williamson, O. (1985). Asset specificity and economic organization. Interna-
tional Journal of Industrial Organization, 3, 365-378.
Savas, E.S. (1987). Privatization: The key to better govemment. Chatham, NJ: Chatham
House Publishers.
Savas, E.S. (2000). Privatization and public-private partnerships. Cambridge, MA: MIT Press.
Sclar, E. (2000). You don't always get what you pay for: The economics of privatization.
Ithaca, NY: Cornell Univei~sity Press.
Segal, G. (2002). Performance measures improve city governments. PA Times, 25(5), pp. 1,9.
Stein, R.M. (1990). Urban alternatives: Public and private markets in the provision of local
services. Pittsburgh: University of Pittsburgh Press.
Stoker, G. (1997). Conclusion: Privatization, urban govemment and the citi/en. In Lorrain &
Stoker (Eds.), The privatization of urban services In Europe. London: Pinter.
Thompson, L., & Elling, R. (2000). Mapping patterns of support for privatization in the mass
public: The case of Michigan. Public Administration Review, 60(4), 338-348.
Walters, J. (2000). The welfare bonanza. Governing, 13(4), 34-36,
Warner, M., & Hedbon, R. (2001). Local govemment restructuring: Privatization and its alter-
natives. Journal of Policy Analysis and Management, 20(2), 315-336.
Weimer, D., & Vining, A. (1992). Policy analysis. Englewood Cliffs, NJ: Prentice-Hall.
Williamson, O. (1981). The economics of organization. American Joumal of Sociology, 87,
548-577.
Williamson, O. (1996). The mechanisms of governance. New York: Oxford University Press.
Williamson, O. (1997). Transaction cost economics and public administration. In Boorsma,
Aai-ts, & Steenge (Eds.), Public priority setting: Rules and costs (pp. 19-37). London:
Kluwer Academic Publishers.
Wise, C.R. (1990). Public service configurations and public organizations: Public organiza-
tion design in the post-privatization era. Public Administration Review, 50(2), 141-155.
Wise, C.R. (1997). The future of public law: Beyond administrative law and national borders.
In Cooper & Newland (Eds.), Handbook of public law and administration (pp. 569-587).
San Francisco: Jossey-Bass.