Bidding for Contracts under Uncertain Demand: Skewed Bidding and Risk Sharing

Abstract

Procurement projects often involve substantial uncertainty in inputs at the time of contracting. Whether the procurer or contractor assumes such risk depends on the specific contractual agreement. Using auction data from the Florida Department of Transportation, we document evidence of i) risk-balancing behavior through the formation of bid portfolios, and ii) opportunistic behavior via skewed bidding. We develop and estimate a model of bidding for contracts where bidders have multidimensional private information. In equilibrium, bidders balance skewed bidding and risk exposure; both efficient and inefficient bidders bid aggressively via skewed bidding. Counterfactual experiments suggest that the onus of bearing project risk should fall on the procurer (contractor) when project risk is large (small).

Keywords: Contract, Unit-Price, Fixed-Price, Portfolio, Cost Overrun, Unobserved Heterogeneity, Procurement, Scoring Auction

JEL Classification: L5