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Limited liability and mechanism design in procurement

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  • Burguet, Roberto
  • Ganuza, Juan-José
  • Hauk, Esther

Abstract

In the presence of cost uncertainty, limited liability introduces the possibility of default in procurement. If financial soundness is not perfectly observable, then financially weaker contractors are selected with higher probability in any incentive compatible mechanism. Informational rents are associated with the probability of default. By selecting the financially weakest contractor, stronger price competition (auctions) may not only increase the probability of default but also the contractorsʼ expected rents. Thus, weak conditions are sufficient for auctions to be suboptimal. In particular, we show that pooling at higher net worth may reduce the cost of procurement even when default is costless for the sponsor.

Suggested Citation

  • Burguet, Roberto & Ganuza, Juan-José & Hauk, Esther, 2012. "Limited liability and mechanism design in procurement," Games and Economic Behavior, Elsevier, vol. 76(1), pages 15-25.
    • Handle: RePEc:eee:gamebe:v:76:y:2012:i:1:p:15-25
    DOI: 10.1016/j.geb.2012.04.004
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    References listed on IDEAS

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    1. 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.
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    4. Burguet, Roberto & Ganuza, Juan-José & Hauk, Esther, 2012. "Limited liability and mechanism design in procurement," Games and Economic Behavior, Elsevier, vol. 76(1), pages 15-25.
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    More about this item

    Keywords

    Procurement; Limited liability; Bankruptcy;
    All these keywords.

    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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