Procurement with Unforeseen Contingencies

Abstract

The procurement of complex projects is often plagued by large cost overruns. One important reason for these additional costs are flaws in the initial design. If the project is procured with a price-only auction, sellers who spotted some of the flaws have no incentive to reveal them early. Each seller prefers to conceal his information until he is awarded the contract and then renegotiate when he is in a bilateral monopoly position with the buyer. We show that this gives rise to three inefficiencies: inefficient renegotiation, inefficient production and inefficient design. We derive the welfare optimal direct mechanism that implements the efficient allocation at the lowest possible cost to the buyer. The direct mechanism, however, imposes strong assumptions on the buyer's prior knowledge of possible flaws and their payoff consequences. Therefore, we also propose an indirect mechanism that implements the same allocation but does not require any such prior knowledge. The optimal direct and indirect mechanisms separate the improvement of the design and the selection of the seller who produces the good. JEL classification numbers: D44; D82; D83; H57.

Public procurement and reputation. An agent‐based model

“…The present paper contributes to this literature by investigating whether and how including firm reputation in public procurement decisions affects the final cost of the contract. We recognize that these issues depend on the behavior of both the parties to the contract and the nature of the contract (e.g., Herweg & Schmidt, 2020). We propose a simple theoretical framework to analyze the behavior of an unspecified procurer under general conditions.…”

Public Procurement and Reputation: An Agent-Based Model

“…The present paper contributes to this literature by investigating whether and how including firm reputation in public procurement decisions affects the final cost of the contract. We recognize that these issues depend on the behavior of both the parties to the contract and the nature of the contract (e.g., Herweg & Schmidt, 2020). We propose a simple theoretical framework to analyze the behavior of an unspecified procurer under general conditions.…”

Mechanism Design with Narratives

“…Within bilateral trade, the framing of narratives as required inputs or appreciated features seems plausible and natural. Alternatively, consider the procurement of complex goods as in Herweg and Schmidt (2020). Then the narratives could also entail design flaws…”