The buyer-seller risk distribution and competition effects in procurement auctions

Abstract: This thesis investigates how competition effects in government procurement auction are affected by the risk distribution between the procurer and the winning bidder. The risk distribution is linked to the conditions of payment which is assumed to be largely determined by the procurer. Thus, by investigating whether competition effects are different dependent on the risk distribution, this thesis contributes to the previous literature which almost exclusively model competition effects to be determined exogenous sources of uncertainty and characteristics of the market. There is a previous literature on the effects of various payment conditions in auctions but it mostly considers ex post moral hazard issues, and not effects on the competitive behavior at the bidding stage. An econometric analysis is conducted on auctions of infrastructure construction contracts held by the Swedish Transport Administration between 2010 and 2013. The results suggest that the choice of risk distribution can shift an auction from having no competition effects in bidding to strong bid-reducing competition effects. Seemingly, the procurer appears to face a trade-off between avoiding risk and enjoying bid-reducing competition effects. The difference in competition effects between contracts with fixed and more flexible payment conditions is found to increase with the auctioned project’s expected duration. In terms of government procurement policy, the results suggest that it can be cost-efficient for the procuring entity to share the risk with the contractor in risky projects instead of avoiding risk with fixed price contracts. Whilst this may contradict some common notions regarding government procurement, it is in line with the wide use of flexible payment conditions in private-sector procurement. Arguably, the recent decade’s increased ambitions regarding innovation and sustainability in government procurement adds even further weight to these policy considerations for the risk management of procurers.