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Limited liability and mechanism design in procurement

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  • Burguet, Roberto
  • Ganuza, Juan-José
  • Hauk, Esther

Abstract

In the presence of cost uncertainty, limited liability introduces the possibility of default in procurement. If financial soundness is not perfectly observable, then financially weaker contractors are selected with higher probability in any incentive compatible mechanism. Informational rents are associated with the probability of default. By selecting the financially weakest contractor, stronger price competition (auctions) may not only increase the probability of default but also the contractorsʼ expected rents. Thus, weak conditions are sufficient for auctions to be suboptimal. In particular, we show that pooling at higher net worth may reduce the cost of procurement even when default is costless for the sponsor.

Suggested Citation

  • Burguet, Roberto & Ganuza, Juan-José & Hauk, Esther, 2012. "Limited liability and mechanism design in procurement," Games and Economic Behavior, Elsevier, vol. 76(1), pages 15-25.
    • Handle: RePEc:eee:gamebe:v:76:y:2012:i:1:p:15-25
    DOI: 10.1016/j.geb.2012.04.004
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    1. Aleix Calveras & Juan-Jose Ganuza & Esther Hauk, 2004. "Wild Bids. Gambling for Resurrection in Procurement Contracts," Journal of Regulatory Economics, Springer, vol. 26(1), pages 41-68, July.
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    4. Zheng, Charles Z., 2001. "High Bids and Broke Winners," Journal of Economic Theory, Elsevier, vol. 100(1), pages 129-171, September.
    5. Burguet, Roberto & Ganuza, Juan-José & Hauk, Esther, 2012. "Limited liability and mechanism design in procurement," Games and Economic Behavior, Elsevier, vol. 76(1), pages 15-25.
    6. Manelli, Alejandro M & Vincent, Daniel R, 1995. "Optimal Procurement Mechanisms," Econometrica, Econometric Society, vol. 63(3), pages 591-620, May.
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    8. Simon Board, 2007. "Bidding into the Red: A Model of Post‐Auction Bankruptcy," Journal of Finance, American Finance Association, vol. 62(6), pages 2695-2723, December.
    9. Andreas R. Engel & Achim Wambach, 2006. "Public Procurement Under Limited Liability," Rivista di Politica Economica, SIPI Spa, vol. 96(1), pages 13-40, January-F.
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    11. Roger B. Myerson, 1981. "Optimal Auction Design," Mathematics of Operations Research, INFORMS, vol. 6(1), pages 58-73, February.
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    Cited by:

    1. Oleksii Birulin & Sergei Izmalkov, 2022. "On advance payments in tenders with budget constrained contractors," RAND Journal of Economics, RAND Corporation, vol. 53(4), pages 733-762, December.
    2. Gottlieb, Daniel & Moreira, Humberto, 2022. "Simple contracts with adverse selection and moral hazard," LSE Research Online Documents on Economics 114348, London School of Economics and Political Science, LSE Library.
    3. Tymofiy Mylovanov & Andriy Zapechelnyuk, 2017. "Optimal Allocation with Ex Post Verification and Limited Penalties," American Economic Review, American Economic Association, vol. 107(9), pages 2666-2694, September.
    4. Pagnozzi, Marco & Saral, Krista J., 2019. "Auctions with limited liability through default or resale," Journal of Economic Behavior & Organization, Elsevier, vol. 159(C), pages 51-74.
    5. Indranil Chakraborty & Fahad Khalil & Jacques Lawarree, 2021. "Competitive procurement with ex post moral hazard," RAND Journal of Economics, RAND Corporation, vol. 52(1), pages 179-206, March.
    6. Philippe Jehiel & Laurent Lamy, 2020. "On the Benefits of Set-Asides," Journal of the European Economic Association, European Economic Association, vol. 18(4), pages 1655-1696.
    7. Antonio Estache & Renaud Foucart & Tomas Serebrisky, 2022. "When can lotteries improve public procurement processes?," Working Papers 359001116, Lancaster University Management School, Economics Department.
    8. Fabian Herweg & Marco A. Schwarz, 2018. "Optimal Cost Overruns: Procurement Auctions With Renegotiation," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 59(4), pages 1995-2021, November.
    9. Decarolis, Francesco & Mattera, Gianpiero & Menon, Carlo, 2020. "Delays at the Border: Court Efficiency and Delays in Public Contracts," CEPR Discussion Papers 14856, C.E.P.R. Discussion Papers.
    10. Ottorino Chillemi & Claudio Mezzetti, 2014. "Optimal procurement mechanisms: bidding on price and damages for breach," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 55(2), pages 335-355, February.
    11. David Martimort & Stéphane Straub, 2016. "How To Design Infrastructure Contracts In A Warming World: A Critical Appraisal Of Public–Private Partnerships," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 57(1), pages 61-88, February.
    12. Burguet, Roberto & Ganuza, Juan-José & Hauk, Esther, 2012. "Limited liability and mechanism design in procurement," Games and Economic Behavior, Elsevier, vol. 76(1), pages 15-25.
    13. Lorentziadis, Panos L., 2016. "Optimal bidding in auctions from a game theory perspective," European Journal of Operational Research, Elsevier, vol. 248(2), pages 347-371.
    14. Wei-Shiun Chang & Timothy C. Salmon & Krista J. Saral, 2016. "Procurement Auctions With Renegotiation And Wealth Constraints," Economic Inquiry, Western Economic Association International, vol. 54(3), pages 1684-1704, July.
    15. Gian Luigi Albano & Berardino Cesi & Alberto Iozzi, 2023. "Teaching an old dog a new trick: Reserve price and unverifiable quality in repeated procurement," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 32(2), pages 377-399, April.
    16. Kreiss, Jan & Ehrhart, Karl-Martin & Haufe, Marie-Christin, 2017. "Appropriate design of auctions for renewable energy support – Prequalifications and penalties," Energy Policy, Elsevier, vol. 101(C), pages 512-520.
    17. Herweg, Fabian & Schwarz, Marco A., 2016. "Optimal Cost Overruns: Procurement Auctions and Renegotiation," CEPR Discussion Papers 11179, C.E.P.R. Discussion Papers.
    18. Leonardo M. Giuffrida & Gabriele Rovigatti, 2022. "Supplier selection and contract enforcement: Evidence from performance bonding," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 31(4), pages 980-1019, November.
    19. Birulin, Oleksii, 2020. "Optimality of simple procurement auctions," International Journal of Industrial Organization, Elsevier, vol. 70(C).
    20. Hatsumi, Kentaro & Ishii, Rieko, 2022. "The effect of price on the quality of public construction in Japan," Japan and the World Economy, Elsevier, vol. 62(C).
    21. Lagziel, David, 2019. "Credit auctions and bid caps," Games and Economic Behavior, Elsevier, vol. 113(C), pages 416-422.
    22. Vlad Radoias & Simon J. Wilkie & Michael A. Williams, 2017. "Rules of evidence and liability in contract litigation: The efficiency of the General Dynamics rule," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 19(6), pages 1139-1150, December.
    23. Wang Tao & Wang Ruqu, 2018. "Limited Liability and High Bids in English Auctions," The B.E. Journal of Theoretical Economics, De Gruyter, vol. 18(2), pages 1-12, July.
    24. David Martimort & Stéphane Straub, 2016. "How To Design Infrastructure Contracts In A Warming World: A Critical Appraisal Of Public–Private Partnerships," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 57, pages 61-88, February.
    25. Lorentziadis, Panos L., 2014. "Bidding under auctioneer default risk," Omega, Elsevier, vol. 49(C), pages 123-133.

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    More about this item

    Keywords

    Procurement; Limited liability; Bankruptcy;
    All these keywords.

    JEL classification:

    • L51 - Industrial Organization - - Regulation and Industrial Policy - - - Economics of Regulation
    • H57 - Public Economics - - National Government Expenditures and Related Policies - - - Procurement
    • D44 - Microeconomics - - Market Structure, Pricing, and Design - - - Auctions

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