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Competition And Cost Overruns In Procurement

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  • JUAN‐JOSÉ GANUZA

Abstract

Most cases of cost overruns in public procurement are related to important changes in the initial project design. This paper provides a rationale for the observed pattern in public procurement of underinvestment in design specification. We propose a two‐stage model in which the sponsor first decides how much to invest in design specification and auctions the project to horizontally differentiated contractors. After the contract has been awarded and implemented, the sponsor and contractor receive new information about the optimal project design and renegotiate the contract to accommodate changes in the initial project's design. We show that the sponsor's optimal strategy is to underinvest in design specification, which makes significant cost overruns likely. Since no such underinvestment occurs when contractors are not horizontally differentiated, cost overruns are seen to arise as a consequence of lack of competition in the procurement market.

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  • Juan‐José Ganuza, 2007. "Competition And Cost Overruns In Procurement," Journal of Industrial Economics, Wiley Blackwell, vol. 55(4), pages 633-660, December.
    • Handle: RePEc:bla:jindec:v:55:y:2007:i:4:p:633-660
    DOI: 10.1111/j.1467-6451.2007.00324.x
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    1. Bajari, Patrick & Tadelis, Steven, 2001. "Incentives versus Transaction Costs: A Theory of Procurement Contracts," RAND Journal of Economics, The RAND Corporation, vol. 32(3), pages 387-407, Autumn.
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    More about this item

    JEL classification:

    • L51 - Industrial Organization - - Regulation and Industrial Policy - - - Economics of Regulation
    • H57 - Public Economics - - National Government Expenditures and Related Policies - - - Procurement
    • D44 - Microeconomics - - Market Structure, Pricing, and Design - - - Auctions

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