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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. Roberto Burguet & Juan-José Ganuza & Esther Hauk, 2009. "Limited Liability and Mechanism Design in Procurement," Working Papers 383, Barcelona Graduate School of Economics.
  2. 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.
  3. Aleix Calveras & Juan J. Ganuza & Esther Hauk, 2001. "Wild bids. Gambling for resurrection in procurement contracts," Economics Working Papers 553, Department of Economics and Business, Universitat Pompeu Fabra, revised Apr 2001.
  4. Parlane, S., 1998. "Procurement Contracts under Limited Liability," Papers 98/3, College Dublin, Department of Political Economy-.
  5. Alejandro M. Manelli & Daniel R. Vincent, 1992. "Optimal Procurement Mechanisms," Discussion Papers 999, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  6. White, Michelle J, 1989. "The Corporate Bankruptcy Decision," Journal of Economic Perspectives, American Economic Association, vol. 3(2), pages 129-51, Spring.
  7. Zheng, Charles Zhoucheng, 2001. "High Bids and Broke Winners," Staff General Research Papers 12665, Iowa State University, Department of Economics.
  8. Waehrer Keith, 1995. "A Model of Auction Contracts with Liquidated Damages," Journal of Economic Theory, Elsevier, vol. 67(2), pages 531-555, December.
  9. 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.
  10. 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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Cited by:
  1. 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.
  2. 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).

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