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Limited Liability and Mechanism Design in Procurement

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  • Roberto Burguet

    ()

  • Juan-José Ganuza

    ()

  • Esther Hauk

    ()

Abstract

In 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 Info

Paper 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.

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Length: 31
Date of creation: 20 Apr 2009
Date of revision:
Handle: RePEc:aub:autbar:767.09

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Keywords: Procurement; limited liability; bankruptcy;

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References

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  1. 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.
  2. 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.
  3. Waehrer Keith, 1995. "A Model of Auction Contracts with Liquidated Damages," Journal of Economic Theory, Elsevier, vol. 67(2), pages 531-555, December.
  4. Sarah Parlane, 2003. "Procurement Contracts under Limited Liability," The Economic and Social Review, Economic and Social Studies, vol. 34(1), pages 1–21.
  5. Zheng, Charles Z., 2001. "High Bids and Broke Winners," Journal of Economic Theory, Elsevier, vol. 100(1), pages 129-171, September.
  6. 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).
  7. 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.
  8. 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, 07.
  9. Manelli, Alejandro M & Vincent, Daniel R, 1995. "Optimal Procurement Mechanisms," Econometrica, Econometric Society, vol. 63(3), pages 591-620, May.
  10. White, Michelle J, 1989. "The Corporate Bankruptcy Decision," Journal of Economic Perspectives, American Economic Association, vol. 3(2), pages 129-51, Spring.
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Cited by:
  1. Roberto Burguet & Juan-José Ganuza & Esther Hauk, 2009. "Limited Liability and Mechanism Design in Procurement," Working Papers 383, Barcelona Graduate School of Economics.
  2. Ottorino Chillemi & Claudio Mezzetti, 2014. "Optimal procurement mechanisms: bidding on price and damages for breach," Economic Theory, Springer, vol. 55(2), pages 335-355, February.

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