Competition and cost overruns. Optimal misspecification of procurement contracts

Juan-José Ganuza

Economics Working Papers from Department of Economics and Business, Universitat Pompeu Fabra

Abstract: Most cases of cost overruns in public procurement are related to important changes in the initial project design. This paper deals with the problem of design specification in public procurement and provides a rationale for design misspecification. We propose a model in which the sponsor decides how much to invest in design specification and awards competitively the project to a contractor. After the project has been awarded the sponsor engages in bilateral renegotiation with the contractor, in order to accommodate changes in the initial project’s design that new information makes desirable. When procurement takes place in the presence of horizontally differentiated contractors, the design’s specification level is seen to affect the resulting degree of competition. The paper highlights this interaction between market competition and design specification and shows that the sponsor’s optimal strategy, when facing an imperfectly competitive market supply, is to underinvest in design specification so as to make significant cost overruns likely. Since no such misspecification occurs in a perfectly competitive market, cost overruns are seen to arise as a consequence of lack of competition in the procurement market.

Keywords: Cost overruns; procurement contracts; strategic ignorance (search for similar items in EconPapers)
JEL-codes: D44 H57 L51 (search for similar items in EconPapers)
Date: 1998-10, Revised 2002-03
New Economics Papers: this item is included in nep-ind
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:upf:upfgen:471

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