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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 bankruptcy 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 sufficient for auctions to be supoptimal. 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 Barcelona Graduate School of Economics in its series Working Papers with number 383.

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Date of creation: Apr 2009
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Handle: RePEc:bge:wpaper:383

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Keywords: Procurement; Limited Liability; Bankruptcy;

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References

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  1. Zheng, Charles Zhoucheng, 2001. "High Bids and Broke Winners," Staff General Research Papers, Iowa State University, Department of Economics 12665, Iowa State University, Department of Economics.
  2. Aleix Calveras & Juan-Jose Ganuza & Esther Hauk, 2004. "Wild Bids. Gambling for Resurrection in Procurement Contracts," Journal of Regulatory Economics, Springer, Springer, vol. 26(1), pages 41-68, 07.
  3. Roberto Burguet & Juan-José Ganuza & Esther Hauk, 2009. "Limited Liability and Mechanism Design in Procurement," Working Papers 383, Barcelona Graduate School of Economics.
  4. Parlane, S., 1998. "Procurement Contracts under Limited Liability," Papers, College Dublin, Department of Political Economy- 98/3, College Dublin, Department of Political Economy-.
  5. Andreas R. Engel & Achim Wambach, 2006. "Public Procurement Under Limited Liability," Rivista di Politica Economica, SIPI Spa, SIPI Spa, vol. 96(1), pages 13-40, January-F.
  6. Alejandro M. Manelli & Daniel R. Vincent, 1992. "Optimal Procurement Mechanisms," Discussion Papers, Northwestern University, Center for Mathematical Studies in Economics and Management Science 999, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  7. Francesco Decarolis, 2009. "When the highest bidder loses the auction: theory and evidence from public procurement," Temi di discussione (Economic working papers), Bank of Italy, Economic Research and International Relations Area 717, Bank of Italy, Economic Research and International Relations Area.
  8. Simon Board, 2007. "Bidding into the Red: A Model of Post-Auction Bankruptcy," Journal of Finance, American Finance Association, American Finance Association, vol. 62(6), pages 2695-2723, December.
  9. White, Michelle J, 1989. "The Corporate Bankruptcy Decision," Journal of Economic Perspectives, American Economic Association, American Economic Association, vol. 3(2), pages 129-51, Spring.
  10. Waehrer Keith, 1995. "A Model of Auction Contracts with Liquidated Damages," Journal of Economic Theory, Elsevier, Elsevier, vol. 67(2), pages 531-555, December.
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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, Springer, vol. 55(2), pages 335-355, February.

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