DP2676 Investment Incentives in Procurement Auctions

Author(s): Leandro Arozamena, Estelle Cantillon
Publication Date: January 2001
Keyword(s): Asymmetric Auctions, Endogenous Distributions, Investment Incentives
JEL(s): C70, D40, L10
Programme Areas: Industrial Organization
Link to this Page: www.cepr.org/active/publications/discussion_papers/dp.php?dpno=2676

We investigate firms' incentives for cost reduction in the first price sealed bid auction, a format largely used for procurement. A central feature of the model is that we allow firms to be heterogeneous. Though private value first price auctions are not games with monotonic best responses, we find that for comparative statistic purposes they behave like these games. In particular, firms will tend to underinvest in cost reduction because they anticipate fiercer head-on competition. Using the second price auction as a benchmark, we also find that the first price auction will elicit less investment from market participants. Moreover, both auction formats tend to favour investment by the current market leader and are therefore likely to reinforce asymmetries among market participants.