Seminar

Procurement with Unforeseen Contingencies

Fabian Herweg (University of Bayreuth)

March 6, 2017, 14:00–15:30

Room MF 323

Industrial Organization seminar

Abstract

The procurement of complex projects is often plagued by large cost overruns. An important reason for these additional costs are flaws in the initial design. If the project is procured with a price-only auction, sellers who spotted some of these flaws have no incentive to reveal them early, which can give rise to three inefficiencies: inefficient renegotiation, inefficient production, and inefficient design. We show that the buyer can mitigate these problems by using an appropriate mechanism; i.e., we derive the informationally robust -- ex post incentive compatible -- direct mechanism that implements the efficient allocation at the lowest possible cost to the buyer. The mechanism uncouples the creation of the design from production. In particular, the expertise of all potential sellers is used to create the best design ex ante, which is then produced by the seller with the lowest cost. Moreover, we show that there is a practically feasible indirect mechanism that implements the same allocation as the optimal direct mechanism. Importantly, the buyer does not need to have any prior knowledge of possible flaws.(joint work with Klaus M. Schmidt)