Oleksii Birulin

Optimal Auctions of Procurement Contracts

Introduction

Optimal auctions of procurement contracts. Explore optimal procurement auctions for non-existent items. Mitigate cost overruns & contractor defaults with strategic contracts and competitive bidding to minimize buyer's expected costs.

Abstract

We consider tenders/auctions for the procurement of items that do not exist at the time of the tender. The cost of production is subject to ex-post shocks, i.e. cost overruns, which cannot be contracted away or insured at the time of tender. The contractors may default due to the cost overruns once the project is underway. We consider a simple contract that specifies the payment in case of default and the award that is paid upon successful project completion. This contract is allocated at the tender and the award part is determined by competitive bidding. We characterize bidding behaviour of contractors in standard tenders and derive the implications for the buyer’s expected cost minimization.

Review

This paper tackles a highly relevant and complex problem in procurement: the tendering of projects or goods that do not yet exist, and whose production costs are subject to significant, uninsurable ex-post shocks. The central challenge addressed is the risk of contractor default stemming from these cost overruns once a project is underway. By introducing a "simple contract" that specifies both a default payment and a completion award, and then analyzing competitive bidding for the award component, the authors aim to characterize contractor behavior and derive optimal strategies for the buyer's expected cost minimization. This topic is of considerable practical importance for large-scale infrastructure, defense, or R&D projects where unforeseen costs are a persistent issue. The strength of this research lies in its focus on the practical realities of such procurement environments, particularly the explicit consideration of ex-post shocks that cannot be contracted away or insured ex-ante. The proposed "simple contract" framework, encompassing both default payments and completion awards, offers a tractable and intuitive mechanism to analyze these challenges. By characterizing bidding behavior within this framework, the paper promises to provide valuable insights into how contractors strategize under significant uncertainty and default risk. Ultimately, the objective of deriving implications for the buyer's expected cost minimization positions the work to offer direct, actionable guidance for organizations engaging in these high-stakes procurement activities. While the abstract outlines a compelling research agenda, it raises several questions that could be further elaborated in the full paper. The title, "Optimal Auctions," suggests a mechanism design approach, yet the abstract mentions "standard tenders," implying an analysis of existing mechanisms. It would be beneficial to clarify whether the paper designs a new optimal auction mechanism or identifies optimal strategies for the buyer *within* existing, standard tender structures, especially concerning the determination of the default payment. Furthermore, a deeper dive into the specific nature of the ex-post shocks (e.g., common vs. idiosyncratic, their distribution) and the information structure regarding contractors' costs would enhance the robustness and generalizability of the findings. Exploring the practical implications beyond expected cost minimization, such as project completion rates or quality outcomes, could also broaden the paper's impact.

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