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Limited Liability and Mechanism Design in Procurement

AuthorsBurguet, Roberto ; Ganuza, Juan José; Hauk, Esther
Limited liability
Issue Date20-Apr-2009
SeriesUFAE and IAE Working Papers ; 767.09
AbstractIn the presence of cost uncertainty, limited liability introduces the possibility of default in procurement with its associated bank-ruptcy costs. When financial soundness is not perfectly observable, we show that incentive compatibility implies that financially less sound contractors are selected with higher probability in any feasible mechanism. Informational rents are associated with unsound financial situations. By selecting the financially weakest contractor, stronger price competition (auctions) may not only increase the probability of default but also expected rents. Thus, weak conditions are suffcient for auctions to be suboptimal. In particular, we show that pooling firms with higher assets may reduce the cost of procurement even when default is costless for the sponsor.
Description31 pages.-- JEL Classification Numbers: L51, H57, D44.-- Trabajo presentado a: "The 8th Annual International Industrial Organization Conference" celebrada en Canada en 2010; "European Summer Symposion in Economic Theory" celebrado en Suiza en 2010; "Econometric Society 10th World Congress" celebrado en China en 2010.
Publicado en: Games and Economic Behavior 76(1): 15-25 (2012), DOI 10.1016/j.geb.2012.04.004
Publisher version (URL)http://pareto.uab.es/wp/2009/76709.pdf
Appears in Collections:(IAE) Informes y documentos de trabajo
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