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Optimal penalty for investment delay in public procurement contracts

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Author Info

  • Chiara D'Alpaos

    ()
    (Universita' di Padova)

  • Michele Moretto

    ()
    (Universita' di Padova)

  • Paola Valbonesi

    ()
    (Universita' di Padova)

Abstract

Our 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 Info

Paper provided by Dipartimento di Scienze Economiche "Marco Fanno" in its series "Marco Fanno" Working Papers with number 0074.

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Length: 21 pages
Date of creation: May 2008
Date of revision:
Handle: RePEc:pad:wpaper:0074

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Related research

Keywords: public procurement contracts; penalty fee; investment timing flexibility; investment irreversibility; contract incompleteness; enforceability of rules.;

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  1. Dalen, Dag Morten & Moen, Espen R & Riis, Christian, 2004. "Contract Renewal and Incentives in Public Procurement," CEPR Discussion Papers 4540, C.E.P.R. Discussion Papers.
  2. Luca Anderlini & Leonardo Felli & Andrew Postlewaite, 2003. "Courts of law and unforeseen contingencies," LSE Research Online Documents on Economics 3576, London School of Economics and Political Science, LSE Library.
  3. McDonald, Robert & Siegel, Daniel, 1986. "The Value of Waiting to Invest," The Quarterly Journal of Economics, MIT Press, vol. 101(4), pages 707-27, November.
  4. Moretto Michele & Valbonesi Paola, 2007. "Firm Regulation and Profit Sharing: A Real Option Approach," The B.E. Journal of Economic Analysis & Policy, De Gruyter, vol. 7(1), pages 1-34, November.
  5. Dosi, Cesare & Moretto, Michele, 2006. "Concession Bidding Rules and Investment Time Flexibility," Conference Papers 6630, University of Minnesota, Center for International Food and Agricultural Policy.
  6. Eduardo Engel & Ronald Fischer & Alexander Galetovic, 2006. "Renegotiation without Holdup: Anticipating Spending and Infrastructure Concessions," Cowles Foundation Discussion Papers 1567, Cowles Foundation for Research in Economics, Yale University.
  7. Cox, John C. & Ross, Stephen A., 1976. "The valuation of options for alternative stochastic processes," Journal of Financial Economics, Elsevier, vol. 3(1-2), pages 145-166.
  8. Patrick Bajari & Steven Tadelis, 1999. "Incentives versus Transaction Costs: A Theory of Procurement Contracts," Working Papers 99029, Stanford University, Department of Economics.
  9. Cristina Fabrizi & Piero Casadio & Roberto Cullino & Chiara Bentivogli, 2007. "Concorrenza e trasparenza nel mercato delle opere pubbliche locali: un'indagine empirica," ECONOMIA E POLITICA INDUSTRIALE, FrancoAngeli Editore, vol. 2007(2), pages 71-103.
  10. McDonald, Robert L & Siegel, Daniel R, 1985. "Investment and the Valuation of Firms When There Is an Option to Shut Down," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 26(2), pages 331-49, June.
  11. Brennan, Michael J & Schwartz, Eduardo S, 1985. "Evaluating Natural Resource Investments," The Journal of Business, University of Chicago Press, vol. 58(2), pages 135-57, April.
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