Procurement and Debt

Abstract

This paper studies dynamic procurement design and the effect of fundamental differences in the way firms fund their market participation on this design. In a two-period model, at each period a procurement contract splits the production of a good between two firms and both sole and dual sourcing are a priori allowed. Firms differ in their ability to self-finance their presence in the market. I study the optimal financial contract for the firm in need of funding and the optimal procurement contract in a setting with both a self-financed and a cash-constrained firm. The main result is that it is optimal for the procurement agency to take into account the financial structure of the competing firms when choosing production quantities. However, what firm to favor is ambiguous and the different effects are identified in this paper.