Teaching an Old Dog a New Trick: Reserve Price and Unverifiable Quality in Repeated Procurement
37 Pages Posted: 24 Oct 2017
Date Written: October 23, 2017
In many circumstances, procurement contracts entail crucial unverifiable dimensions. In a repeated procurement auction framework, we show that by strategically using the reserve price, a buyer is able to elicit the provision of unverifiable quality. Thus the buyer need not resort to any past-performance-related mechanism, which makes the analysis relevant to those regulatory environments in which past performance cannot be used as a criterion to evaluate tenders.
We study an infinitely repeated procurement model with many firms and one buyer who is imperfectly informed on the firms' cost. In each period, the buyer runs a standard low-price auction with reserve price. We study the cases of players using grim trigger strategies, analysing both the case of a committed and uncommitted buyer. We find that a competitive process with reserve price is able to elicit the desired level of unverifiable quality provided that the buyer's valuation of the project is not too high and the value of additional unverifiable quality is not too low; under these conditions, the buyer can credibly threaten the firms to set, in case a contractor fails to deliver the required quality level, a reserve price so low that the selected contractor (if any) makes zero profits. A committed buyer can elicit the desired quality level for a wider range of preference parameters.
Keywords: Public Procurement, Relational Contracts, Unverifiable Quality, Reserve Price
JEL Classification: D44, H57, K23
Suggested Citation: Suggested Citation