Optimal penalty for investment delay in public procurement contracts

Chiara D'Alpaos (), Michele Moretto and Paola Valbonesi
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Chiara D'Alpaos: Universita' di Padova

No 74, "Marco Fanno" Working Papers from Dipartimento di Scienze Economiche "Marco Fanno"

Abstract: Our aim in this paper is to provide a general framework in which to determine the optimal penalty fee inducing the contractor to respect the contracted delivery date in public procurement contracts (PPCs). We do this by developing a real option model that enables us to investigate the contractor's value of investment timing flexibility which the penalty rule - de facto - introduces. We then apply this setting in order to evaluate the range of penalty fees in the Italian legislation on PPCs: according to our calibration analysis, there is no evidence that the substantial delays recorded in the execution times of Italian investments are to be due to incorrectly set penalty fees. This result opens the way for other explanations of delays in PPCs: we thus extend our model to include the probability that the penalty is ineffectively enforced and study how calibration results are accordingly affected. We finally show how our model can be used to investigate both the case of a penalty/premium rule and the one of an optimal penalty fee in a concession contract.

Keywords: public procurement contracts; penalty fee; investment timing flexibility; investment irreversibility; contract incompleteness; enforceability of rules. (search for similar items in EconPapers)
JEL-codes: D81 H57 L33 (search for similar items in EconPapers)
Pages: 21 pages
Date: 2008-05
New Economics Papers: this item is included in nep-cta and nep-pbe
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