Limited Liability and Mechanism Design in Procurement

Roberto Burguet, Juan-José Ganuza and Esther Hauk

UFAE and IAE Working Papers from Unitat de Fonaments de l'Anàlisi Econòmica (UAB) and Institut d'Anàlisi Econòmica (CSIC)

Abstract: In the presence of cost uncertainty, limited liability introduces the possibility of default in procurement with its associated bank-ruptcy costs. When financial soundness is not perfectly observable, we show that incentive compatibility implies that financially less sound contractors are selected with higher probability in any feasible mechanism. Informational rents are associated with unsound financial situations. By selecting the financially weakest contractor, stronger price competition (auctions) may not only increase the probability of default but also expected rents. Thus, weak conditions are suffcient for auctions to be suboptimal. In particular, we show that pooling firms with higher assets may reduce the cost of procurement even when default is costless for the sponsor.

Keywords: Procurement; limited liability; bankruptcy (search for similar items in EconPapers)
JEL-codes: D44 H57 L51 (search for similar items in EconPapers)
Pages: 31
Date: 2009-04-20
New Economics Papers: this item is included in nep-cta
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Citations: View citations in EconPapers (2)

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Related works:
Working Paper: Limited Liability and Mechanism Design in Procurement (2015)
Journal Article: Limited liability and mechanism design in procurement (2012)
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Persistent link: https://EconPapers.repec.org/RePEc:aub:autbar:767.09

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