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.