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Managing Procurement Auction Failure: Bid Requirements or Reserve Prices

Jun Ma, Vadim Marmer, Pai Xu

Abstract

This paper examines bid requirements, where the government may cancel a procurement contract unless two or more bids are received. Using a first-price auction model with endogenous entry, we compare the bid requirement and reserve price mechanisms in terms of auction failure and procurement costs. We find that, in comparison with bid requirements, reserve prices can reduce procurement costs and substantially lower failure probabilities, especially when entry costs are high or signals are sufficiently informative. Bid requirements are more likely to result in zero entry, while reserve prices can sustain positive entry under broader conditions.

Managing Procurement Auction Failure: Bid Requirements or Reserve Prices

Abstract

This paper examines bid requirements, where the government may cancel a procurement contract unless two or more bids are received. Using a first-price auction model with endogenous entry, we compare the bid requirement and reserve price mechanisms in terms of auction failure and procurement costs. We find that, in comparison with bid requirements, reserve prices can reduce procurement costs and substantially lower failure probabilities, especially when entry costs are high or signals are sufficiently informative. Bid requirements are more likely to result in zero entry, while reserve prices can sustain positive entry under broader conditions.

Paper Structure

This paper contains 22 sections, 5 theorems, 67 equations, 9 figures, 4 tables.

Table of Contents

  1. Introduction
  2. Background
  3. Model and auction formats
  4. Model
  5. Bid requirement format
  6. Reserve price format
  7. Role of signal informativeness
  8. Semiparametric identification and estimation
  9. Identification
  10. Estimation
  11. Estimation results
  12. Data
  13. Entry probabilities, signal informativeness, entry costs, and distribution of private costs
  14. Format comparisons
  15. Fixed signal informativeness
  16. ...and 7 more sections

Key Result

Proposition 3.1

Suppose that Assumption a:copula_1 holds. If $p(n,\kappa)>0$, then it satisfies:

Figures (9)

  • Figure 1: The marginal entrant's estimated expected revenue (solid line) and entry cost (dashed line), as fractions of the engineer's estimate, under the two formats for different entry probabilities, estimated using the TxDoT data for auctions with 14 potential bidders
  • Figure 2: Expected revenue curves for three different signal realizations $s=0.21$ (red), $0.26$ (black), and $0.31$ (blue). The middle curve corresponding to $s = 0.26$ intersects the entry cost $\kappa$ at $p = 0.26$, establishing the equilibrium type of the marginal entrant.
  • Figure 3: Estimates of the entry probability $p_n$, entry cost $\kappa_n$, and CDF $F(\cdot)$ of private costs
  • Figure 4: Counterfactual auction failure probabilities and expected winning bids for different numbers of potential bidders $n$ and estimated weighted average entry cost $\kappa=0.046$ under the bid requirement (dashed line) and reserve price (solid line) formats; the reserve price $r=1$
  • Figure 5: Entry cost and marginal entrant's expected revenue from entry under the bid requirement and reserve price formats in auctions with $n=10$ potential bidders for different entry probabilities and levels of signal informativeness as measured by Spearman's rank correlation $\rho$
  • ...and 4 more figures

Theorems & Definitions (5)

  • Proposition 3.1
  • Proposition 3.2
  • Proposition 3.3
  • Proposition 4.1
  • Proposition 5.1