Oleksii Birulin, Sergei Izmalkov

On cost overruns in procurement

Introduction

On cost overruns in procurement. Explore strategies for managing cost overruns in procurement auctions with ex-post risks and limited liability. Learn how ex-ante/ex-post payment allocation minimizes project costs.

Abstract

We consider auctions/tenders for the procurement of goods and services in the setting where the potential contractors face ex-post risks that may lead to cost overruns. The contractors have limited access to credit and are protected by limited liability. We identify the trade-offs that the procurement agency faces in such settings and show that the procuring agency minimizing the expected costs of the project greatly benefi ts by allocating a share of the award ex-ante, at the time of contracting, with the remainder due ex-post, after the completion of the project.

Review

This paper investigates the critical problem of cost overruns in procurement, a challenge frequently faced by public and private agencies. The authors focus on auction and tender settings where contractors are exposed to ex-post risks, operate under limited access to credit, and are protected by limited liability. The abstract clearly articulates the central objective: to identify the trade-offs faced by procurement agencies in such environments. This work promises to offer valuable insights into designing more robust and efficient procurement mechanisms, positioning itself as highly relevant to both academic research and practical policy-making in contract theory and public economics. A significant strength of this work, as described, lies in its elegant identification of the core trade-offs inherent in these complex procurement scenarios. The proposed solution—allocating a share of the award ex-ante at the time of contracting, with the remainder due ex-post upon project completion—is a crucial contribution. This mechanism is shown to greatly benefit the procuring agency by minimizing expected project costs, suggesting a novel approach to risk sharing and incentive alignment that effectively mitigates the combined challenges of ex-post risk, credit constraints, and limited liability. The clarity with which this central finding is presented highlights its potential to significantly improve current procurement practices. While the abstract provides a compelling overview, it raises several interesting avenues for further exploration that could enrich the analysis. It would be beneficial to understand the nature of the ex-post risks in more detail—are they symmetric or asymmetric, verifiable or non-verifiable? Additionally, a deeper discussion on the precise mechanism for determining the *optimal* ex-ante share, and how this share might vary with different project types or market conditions, would add considerable value. Finally, exploring how this proposed structure compares to or complements other common risk mitigation strategies, such as insurance or performance bonds, could further solidify the practical implications and distinct advantages of the authors' approach.

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