DP10284 Auctions vs. Negotiations: The Effects of Inefficient Renegotiation
|Author(s):||Fabian Herweg, Klaus M. Schmidt|
|Publication Date:||December 2014|
|Keyword(s):||adaptation costs, auctions, behavioral contract theory, loss aversion, negotiations, procurement, renegotiations|
|JEL(s):||D03, D82, D83, H57|
|Programme Areas:||Industrial Organization|
|Link to this Page:||cepr.org/active/publications/discussion_papers/dp.php?dpno=10284|
For the procurement of complex goods the early exchange of information is important to avoid costly renegotiation ex post. We show that this is achieved by bilateral negotiations but not by auctions. Negotiations strictly outperforms auctions if sellers are likely to have superior information about possible design improvements, if renegotiation is costly, and if the buyer's bargaining position is sufficiently strong. Moreover, we show that negotiations provide stronger incentives for sellers to investigate possible design improvements than auctions. This provides an explanation for the widespread use of negotiations as a procurement mechanism in private industry.