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Optimal procurement mechanisms: bidding on price and damages for breach

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  • Ottorino Chillemi
  • Claudio Mezzetti

    ()

Abstract

We study the optimal procurement mechanism when contract breach and abandoning a project may be efficient, either because of completion costs higher than anticipated or because of new and more lucrative opportunities for the contractor. When contractors have private information about their costs, the procurer finds it optimal to set damages above expectation damages. There is a lock-in effect, or status quo bias; the agent that has won the award will complete the project even in situations when it would be efficient to abandon it. If the cost types of all agents are above a threshold, the optimal bidding procedure assigns the project by lottery. The optimal mechanism cannot be implemented by standard auction formats. However, the larger the number of agents bidding for the project, the closer auctions with a liquidated damage clause approximate the optimal mechanism. Copyright Springer-Verlag Berlin Heidelberg 2014

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Bibliographic Info

Article provided by Springer in its journal Economic Theory.

Volume (Year): 55 (2014)
Issue (Month): 2 (February)
Pages: 335-355

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Handle: RePEc:spr:joecth:v:55:y:2014:i:2:p:335-355

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Web page: http://link.springer.de/link/service/journals/00199/index.htm

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Related research

Keywords: Procurement; Principal-agent; Contract breach; Liquidated damages; D44; D82; H57; L51;

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References

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  1. Roberto Burguet & Juan-José Ganuza & Esther Hauk, 2009. "Limited Liability and Mechanism Design in Procurement," UFAE and IAE Working Papers 767.09, Unitat de Fonaments de l'Anàlisi Econòmica (UAB) and Institut d'Anàlisi Econòmica (CSIC).
  2. Zheng, Charles Z., 2001. "High Bids and Broke Winners," Journal of Economic Theory, Elsevier, vol. 100(1), pages 129-171, September.
  3. Spulber, Daniel F, 1990. "Auctions and Contract Enforcement," Journal of Law, Economics and Organization, Oxford University Press, vol. 6(2), pages 325-44, Fall.
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  6. Chung, Tai-Yeong, 1992. "On the Social Optimality of Liquidated Damage Clauses: An Economic Analysis," Journal of Law, Economics and Organization, Oxford University Press, vol. 8(2), pages 280-305, April.
  7. Stole, Lars A, 1992. "The Economics of Liquidated Damage Clauses in Contractual Environments with Private Information," Journal of Law, Economics and Organization, Oxford University Press, vol. 8(3), pages 582-606, October.
  8. Milgrom,Paul, 2004. "Putting Auction Theory to Work," Cambridge Books, Cambridge University Press, number 9780521536721, October.
  9. Leonardo Rezende, 2009. "Biased procurement auctions," Economic Theory, Springer, vol. 38(1), pages 169-185, January.
  10. Francesco Decarolis, 2009. "When the highest bidder loses the auction: theory and evidence from public procurement," Temi di discussione (Economic working papers) 717, Bank of Italy, Economic Research and International Relations Area.
  11. Matthew Rhodes-Kropf & S. Viswanathan, 2005. "Financing Auction Bids," RAND Journal of Economics, The RAND Corporation, vol. 36(4), pages 789-815, Winter.
  12. Sarah Parlane, 2003. "Procurement Contracts under Limited Liability," The Economic and Social Review, Economic and Social Studies, vol. 34(1), pages 1–21.
  13. Zheng, Charles Zhoucheng, 2009. "The Default-Prone U.S. Toxic Asset Auction Plan," Staff General Research Papers 13056, Iowa State University, Department of Economics.
  14. Spagnolo, Giancarlo & Albano, Gian Luigi & Bianchi, Milo, 2006. "Bid avarage methods in Procurement," MPRA Paper 8997, University Library of Munich, Germany.
  15. Waehrer Keith, 1995. "A Model of Auction Contracts with Liquidated Damages," Journal of Economic Theory, Elsevier, vol. 67(2), pages 531-555, December.
  16. John Asker, 2000. "Bidding up, buying out and cooling-off: an examination of auctions with withdrawal rights," Economic Theory, Springer, vol. 16(3), pages 585-611.
  17. 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.
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