Optimal penalty for investment delay in public procurement contracts
AbstractOur aim in this paper is to provide a general framework in which to determine the optimal penalty fee inducing the contractor to respect the contracted delivery date in public procurement contracts (PPCs). We do this by developing a real option model that enables us to investigate the contractor's value of investment timing flexibility which the penalty rule - de facto - introduces. We then apply this setting in order to evaluate the range of penalty fees in the Italian legislation on PPCs: according to our calibration analysis, there is no evidence that the substantial delays recorded in the execution times of Italian investments are to be due to incorrectly set penalty fees. This result opens the way for other explanations of delays in PPCs: we thus extend our model to include the probability that the penalty is ineffectively enforced and study how calibration results are accordingly affected. We finally show how our model can be used to investigate both the case of a penalty/premium rule and the one of an optimal penalty fee in a concession contract.
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Bibliographic InfoPaper provided by Dipartimento di Scienze Economiche "Marco Fanno" in its series "Marco Fanno" Working Papers with number 0074.
Length: 21 pages
Date of creation: May 2008
Date of revision:
public procurement contracts; penalty fee; investment timing flexibility; investment irreversibility; contract incompleteness; enforceability of rules.;
Find related papers by JEL classification:
- L33 - Industrial Organization - - Nonprofit Organizations and Public Enterprise - - - Comparison of Public and Private Enterprise and Nonprofit Institutions; Privatization; Contracting Out
- H57 - Public Economics - - National Government Expenditures and Related Policies - - - Procurement
- D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
This paper has been announced in the following NEP Reports:
- NEP-ALL-2008-05-17 (All new papers)
- NEP-CTA-2008-05-17 (Contract Theory & Applications)
- NEP-PBE-2008-05-17 (Public Economics)
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