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Procurement under default risk: auctions or lotteries?

Author

Listed:
  • Ottorino Chillemi

    () (University of Padova)

  • Claudio Mezzetti

    (University of Warwick)

Abstract

We study optimal procurement in the presence of default risk. Contractors differ in the penalty they suffer in case of default, which is private information. If the loss to the procurer from non-completion is high relative to the cost of completion, the optimal mechanism is to assign the project by a fair lottery. The procurer pays the winner enough so that the project is always completed and extracts contractors' surplus by charging them participation fees. When the loss to the procurer from non-completion is low relative to the cost of completion, the project is assigned to the contractor with the highest probability of default; that is, the one with the lowest defaulting penalty. The optimal probability of default is inefficiently low: projects that would be first-best efficient not to complete are completed.

Suggested Citation

  • Ottorino Chillemi & Claudio Mezzetti, 2011. "Procurement under default risk: auctions or lotteries?," "Marco Fanno" Working Papers 0131, Dipartimento di Scienze Economiche "Marco Fanno".
  • Handle: RePEc:pad:wpaper:0131
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    More about this item

    Keywords

    procurement; auctions; abnormally low tender; default risk.;

    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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