Limited Liability and Mechanism Design in Procurement
AbstractIn the presence of cost uncertainty, limited liability introduces the possibility of default in procurement with its associated bank-ruptcy costs. When financial soundness is not perfectly observable, we show that incentive compatibility implies that financially less sound contractors are selected with higher probability in any feasible mechanism. Informational rents are associated with unsound financial situations. By selecting the financially weakest contractor, stronger price competition (auctions) may not only increase the probability of default but also expected rents. Thus, weak conditions are suffcient for auctions to be suboptimal. In particular, we show that pooling firms with higher assets may reduce the cost of procurement even when default is costless for the sponsor.
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Bibliographic InfoPaper provided by Unitat de Fonaments de l'Anàlisi Econòmica (UAB) and Institut d'Anàlisi Econòmica (CSIC) in its series UFAE and IAE Working Papers with number 767.09.
Date of creation: 20 Apr 2009
Date of revision:
Procurement; limited liability; bankruptcy;
Other versions of this item:
- 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.
- Roberto Burguet & Juan-José Ganuza & Esther Hauk, 2009. "Limited Liability and Mechanism Design in Procurement," Working Papers 383, Barcelona Graduate School of Economics.
- L51 - Industrial Organization - - Regulation and Industrial Policy - - - Economics of Regulation
- H57 - Public Economics - - National Government Expenditures and Related Policies - - - Procurement
- D44 - Microeconomics - - Market Structure and Pricing - - - Auctions
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