Helping Hampered Bidders – Do Subsidy Auctions Work as Intended?

Abstract

The use of preference or discriminatory auctions, where one class of bidders is offered favored treatment over another class, has received mixed attention in the literature. Research has shown there is often an economic benefit of such policies in procurement auctions thanks to lower costs for buyers as incentives are offered to disadvantaged sellers. In this paper, we study one type of preferential procurement auction: the subsidy. Using a set of controlled experiments, we compare actual bidder behavior to what is predicted in equilibrium and find consistent (but overly aggressive) patterns overall. By testing a common bid strategy assumption, we also identify a behavioral framing bias that may trap sellers in these suboptimal strategies. Finally, we compare subsidies to another common discriminatory mechanism – the price preference – and find evidence that buyers interested in increasing the welfare of disadvantaged sellers should use subsidies instead of price preference auctions, thanks to a surprising difference in outcomes between preference types. Due to the wide use of bid preference auctions to support both policy and social aims, our findings have both financial and societal implications.

Keywords: subsidy, procurement auction, private value, behavioral experiment