Equilibrium Cost Overruns
AbstractCost overruns are endemic in military procurement projects and pervasive in other areas. This paper studies a model in which the apparent cost overruns arise not as systematic expectational errors but as equilibrium phenomena. The possibility of renegotiating payments when cost overruns occur results in firms bidding below their true estimate of expected project costs. This can cause the initial price for a project to be consistently lower than its expected cost, and hence the persistence of cost overruns in equilibrium. The tradeoff between selecting the lowest cost source and inducing efficient investment effort is explored.
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Bibliographic InfoArticle provided by Society for AEF in its journal Annals of Economics and Finance.
Volume (Year): 2 (2001)
Issue (Month): 2 (November)
Cost overrun; Procurement; Cost sharing; Bidding;
Find related papers by JEL classification:
- H57 - Public Economics - - National Government Expenditures and Related Policies - - - Procurement
- L14 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Transactional Relationships; Contracts and Reputation
- D21 - Microeconomics - - Production and Organizations - - - Firm Behavior: Theory
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