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Procurement with Unenforceable Contract Time and the Law of Liquidated Damages

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Author Info

  • Cesare Dosi

    (Department of Economics and Management, University of Padova)

  • Michele Moretto

    (Department of Economics and Management, University of Padova, Centro Studi Levi Cases, Fondazione Eni Enrico Mattei)

Abstract

Time overruns are common in public works and are not confined to inherently complex tasks. One explanation advanced in this paper is that bidders can undergo unpredictable changes in production costs which generate an option value of waiting. By exploiting the real-option approach, we examine how the inability to force sellers to meet the contract time influences their bidding behaviour, and how this can ultimately affect the parties’ expected payoffs. Further, we examine the outcome of the bidding process when legal rules prevent the promisee from contracting for damage measures which would grant more than her lost expectation. We show that when the pre-agreed compensatory payments prove insufficient to discourage delayed orders, setting a liquidated damages clause would not lead to a Pareto superior outcome with respect to the no-damage-for delay condition. While such a clause would increase the seller’s expected payoff, the buyer’s expected payoff is lower than when the contract does not provide for any compensation for late-delivery.

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Bibliographic Info

Paper provided by Fondazione Eni Enrico Mattei in its series Working Papers with number 2012.45.

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Date of creation: Jun 2012
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Handle: RePEc:fem:femwpa:2012.45

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Related research

Keywords: Public Procurement; Fixed-Price Contracts; Cost Uncertainty; Time Overruns; Liquidated Damages; Real Options;

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References

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  1. Nabil Al-Najjar & Luca Anderlini & Leonardo Felli, 2002. "Unforeseen contingencies," LSE Research Online Documents on Economics 3578, London School of Economics and Political Science, LSE Library.
  2. Ram Singh, 2009. "Delays and Cost Overruns in Infrastructure Projects -- An Enquiry into Extents, Causes and Remedies," Working papers 181, Centre for Development Economics, Delhi School of Economics.
  3. Andrzej Skrzypacz & Peter M. DeMarzo & Ilan Kremer, 2004. "Bidding with Securities: Auctions and Security Design," Econometric Society 2004 North American Winter Meetings 641, Econometric Society.
  4. Cesare Dosi & Michele Moretto, 2013. "Auctioning Monopoly Franchises: Award Criteria and Rollout Obligations," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 15(1), pages 53-75, 02.
  5. Michael Garvin & Charles Cheah, 2004. "Valuation techniques for infrastructure investment decisions," Construction Management and Economics, Taylor & Francis Journals, vol. 22(4), pages 373-383.
  6. repec:att:wimass:9123 is not listed on IDEAS
  7. Sergio Vergalli & Chiara D’Alpaos & Michele Moretto & Paola Valbonesi, 2009. ""It Is Never too late": Optimal Penalty for Investment Delay in Public Procurement Contracts," Working Papers 2009.78, Fondazione Eni Enrico Mattei.
  8. Manelli, Alejandro M & Vincent, Daniel R, 1995. "Optimal Procurement Mechanisms," Econometrica, Econometric Society, vol. 63(3), pages 591-620, May.
  9. McAfee, R Preston & McMillan, John, 1987. "Auctions and Bidding," Journal of Economic Literature, American Economic Association, vol. 25(2), pages 699-738, June.
  10. Samuel A. Rea, Jr., 1984. "Efficiency Implications of Penalties and Liquidated Damages," The Journal of Legal Studies, University of Chicago Press, vol. 13(1), pages 147-168, January.
  11. Yeon-Koo Che, 1993. "Design Competition through Multidimensional Auctions," RAND Journal of Economics, The RAND Corporation, vol. 24(4), pages 668-680, Winter.
  12. Calzolari, Giacomo & Spagnolo, Giancarlo, 2009. "Relational Contracts and Competitive Screening," CEPR Discussion Papers 7434, C.E.P.R. Discussion Papers.
  13. Juan José Ganuza, 2003. "Competition and cost overruns in procurement," Economics Working Papers 772, Department of Economics and Business, Universitat Pompeu Fabra.
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Cited by:
  1. Chiara D’Alpaos & Michele Moretto & Paola Valbonesi & Sergio Vergalli, 2012. "Time Overruns as Opportunistic Behavior in Public Procurement," Working Papers 2012.78, Fondazione Eni Enrico Mattei.

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