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Optimal procurement auctions with audit

Author

Listed:
  • Ottorino Chillemi

    (University of Padua)

  • Stefano Galavotti

    (University of Bari)

Abstract

One solution to limit the contractor’s default risk in first-price procurement auctions is to audit the winning firm in order to assess the reliability of its bid, and, in case of an unsatisfactory response, move to the firm that ranked second, and so on. Focussing on a situation in which firms with cheaper technologies have a higher risk of default ex-post, we provide conditions that ensure that a first-price auction with audit is indeed optimal. These conditions are likely to be satisfied when the relation between firms’ cost and default risk is not too steep and when the cost of performing the audit is not too large. We also characterize the optimal threshold that determines which firms are to be audited and which are not. We finally discuss cases in which, instead, a first-price auction with audit is dominated by a mechanism in which the allocation (and the audit) is done randomly, at least at some point of the awarding process.

Suggested Citation

  • Ottorino Chillemi & Stefano Galavotti, 2025. "Optimal procurement auctions with audit," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 79(3), pages 993-1054, May.
    • Handle: RePEc:spr:joecth:v:79:y:2025:i:3:d:10.1007_s00199-024-01609-1
    DOI: 10.1007/s00199-024-01609-1
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    References listed on IDEAS

    as
    1. Ottorino Chillemi & Claudio Mezzetti, 2014. "Optimal procurement mechanisms: bidding on price and damages for breach," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 55(2), pages 335-355, February.
    2. Oleksii Birulin & Sergei Izmalkov, 2022. "On advance payments in tenders with budget constrained contractors," RAND Journal of Economics, RAND Corporation, vol. 53(4), pages 733-762, December.
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    13. Roger B. Myerson, 1981. "Optimal Auction Design," Mathematics of Operations Research, INFORMS, vol. 6(1), pages 58-73, February.
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    More about this item

    Keywords

    Procurement; Auctions; Audit; Bankruptcy; Default risk;
    All these keywords.

    JEL classification:

    • D44 - Microeconomics - - Market Structure, Pricing, and Design - - - Auctions
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • H57 - Public Economics - - National Government Expenditures and Related Policies - - - Procurement
    • L51 - Industrial Organization - - Regulation and Industrial Policy - - - Economics of Regulation

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