ECO.5:5 - Archetypal Grounding

ECO.5:5.1 - Care under an outcome-based payment

A constructed maintenance contract pays €20 plus €30 if a supplied functional test passes. The example assumes a risk-neutral provider, no other relevant costs, a valid test that cannot be cheaply manipulated, and two available choices. Low care costs €4 and passes with probability 0.5; high care costs €12 and passes with probability 0.9.

Expected provider receipts less care cost are €31 for low care and €35 for high care. The €12 increase in expected bonus exceeds the €8 increase in care cost. If the provider’s feasible alternative gives €32, high care both attracts participation and beats low care in this small model. A flat €35 payment would give €31 under low care and €23 under high care, so it would neither attract this provider nor reward the intended action.

For the risk-neutral buyer, suppose a passing result is worth €80, a failing result gives no benefit, and the same test and other costs apply to both offers. The proposed contract gives expected benefit €72 and payment €47, leaving €25. An available alternative provider charges a fixed €50 for the same 0.9 chance of success, leaving €22. The buyer therefore proposes the conditional contract, which the first provider also prefers to its outside alternative. If the passing result were worth only €40 and the buyer could leave the equipment idle without further loss, both offers would give negative expected net benefit; the buyer would decline them.

This establishes the direction of the constructed incentives, not an optimal contract or a prediction about every provider. If the test can be passed while leaving the equipment unreliable, the contract rewards the wrong result. If the provider cannot bear variable receipts, the participation conclusion must be reconsidered.

ECO.5:5.2 - A warranty whose issuer cannot pay

Two sellers offer the same warranty, but one has no resources to honour a claim and can disappear after the sale. The words impose different expected consequences in the two arrangements. A deposit, credible guarantor, repeat relationship or different offer may help; merely lengthening the warranty text does not.