DP11179 Optimal Cost Overruns: Procurement Auctions and Renegotiation

Author(s):	Fabian Herweg, Marco A. Schwarz
Publication Date:	March 2016
Keyword(s):	Auction, Cost Overrun, Procurement, Renegotiation
JEL(s):	D44, D82, H57
Programme Areas:	Industrial Organization
Link to this Page:	cepr.org/active/publications/discussion_papers/dp.php?dpno=11179

Cost overrun is ubiquitous in public procurement. We argue that this can be the result of a constraint optimal award procedure when the procurer cannot commit not to renegotiate. If cost differences are more pronounced for more complex designs, it is optimal to fix a simple design ex ante and to renegotiate to a more complex and costlier design ex post. Specifying a simple design initially enhances competition in the auction. Moreover, the procurer cannot benefit from using a multi-dimensional auction, as the optimal scoring rule depends only on the price.