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Wild Bids. Gambling for Resurrection in Procurement Contracts

Author

Listed:
  • Aleix Calveras

  • Juan-Jose Ganuza

  • Esther Hauk

Abstract

This paper analyses the problem of abnormally low tenders in the procurement process. Limited liability causes firms in a bad financial situation to bid more aggressively than financially healthy firms in the procurement auction. Therefore, it is likely that the winning firm is a firm in financial difficulties with a high risk of bankruptcy. The paper focuses on the regulatory practice of surety bonds to face this problem. We show that the use of surety bonds reduces and sometimes eliminates the problem of abnormally low tenders. We provide a characterization of the optimal surety bond and show that the U.S. practice of requiring that surety bonds cover over 100% of the contract price can be excessive, implying overinsurance to the problem of abnormally low tenders.

Suggested Citation

  • Aleix Calveras & Juan-Jose Ganuza & Esther Hauk, 2004. "Wild Bids. Gambling for Resurrection in Procurement Contracts," Journal of Regulatory Economics, Springer, vol. 26(1), pages 41-68, July.
    • Handle: RePEc:kap:regeco:v:26:y:2004:i:1:p:41-68
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    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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