Equilibrium Cost Overruns
Yongmin Chen () and
Ronald Smith ()
Annals of Economics and Finance, 2001, vol. 2, issue 2, 401-414
Cost overruns are endemic in military procurement projects and pervasive in other areas. This paper studies a model in which the apparent cost overruns arise not as systematic expectational errors but as equilibrium phenomena. The possibility of renegotiating payments when cost overruns occur results in firms bidding below their true estimate of expected project costs. This can cause the initial price for a project to be consistently lower than its expected cost, and hence the persistence of cost overruns in equilibrium. The tradeoff between selecting the lowest cost source and inducing efficient investment effort is explored.
Keywords: Cost overrun; Procurement; Cost sharing; Bidding (search for similar items in EconPapers)
JEL-codes: H57 L14 D21 (search for similar items in EconPapers)
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Persistent link: https://EconPapers.repec.org/RePEc:cuf:journl:y:2001:v:2:i:2:p:401-414
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