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Empirical and Theoretical Analysis of Public Procurement Auctions

Nakabayashi, Jun

Abstract Details

2009, Doctor of Philosophy, Ohio State University, Economics.

Spending approximately 10 percent of the gross domestic product (GDP), governments are the biggest buyer of goods and services for many countries. Sound public procurement policies and practices are essential not only to good governance, but also to a strong and stable economy. On the other hand, due to the fact that more than 99 percent of all businesses are small in most of the countries, the involvement of small businesses are vital for the governments seeking to establish competition, innovation and value for money in the delivery of public goods and services. In fact, small businesses are likely to be disadvantage in production costs and lack in knowledge of available contract opportunities. Moreover, since it naturally would fit better to the small businesses, many of them serve to government contracts as subcontractor. In this thesis, I analyze public procurement auctions both empirically and theoretically, focusing on the role and impact of small businesses in government procurement market. To level the playing field for businesses seeking to bid for public sector contracts, many governments adopt small business programs and provide contract opportunities for businesses operated by members of disadvantaged groups. The federal government, for instance, has its goal of awarding 23 percent of its contracting dollars to small businesses. The redistribution arising from such programs, however, can introduce significant added costs to government procurement budgets. In my first essay “Small Business Set-asides in Procurement Auctions: An Empirical Analysis,” I examine to what extent small business set-asides increase government procurement costs, and how set-asides promote access of the beneficiaries to procurement markets. The estimates employ data on Japanese public construction projects, where approximately 50 percent of the procurement budget is set-aside for small and medium enterprises (SMEs). Using nonparametric estimation of asymmetric first-price auctions with affiliated private values, I find that, in each auction, smaller firms are likely to have higher production costs and obtain less expected profits than larger _rms. Applying such a quantitative relationship between profitability and firm size into the static entry model, I then conduct a counterfactual simulation to indicate that approximately 40 percent of SMEs would exit from the procurement market were set-asides to be removed. Surprisingly, the resulting lack of competition would increase government procurement costs (0.4 percent), more than offsetting the resulting production cost inefficiency.

The second essay “Procurement auctions with pre-award subcontracting” addresses issues in pre-award subcontract competition. To be the lowest bidder in procurement auctions, prime contractors commonly solicit bids from subcontractors at the bid preparation stage. A remarkable feature of the subcontract competition is that winning is not everything; the awarded subcontractor gets a job conditional on his prime contractor’s successful bid. I model a simple two-stage game. Each prime contractor solicits irrevocable price quotes from subcontractors and chooses one in the first stage, assuming that the subcontractors’ costs are private information. Relying on the selected price quote, the prime contractor computes the project cost and bids in the auction at the second stage. I find that, in response to increasing competition in the downstream competition, prime contractors have a stronger bargaining power against subcontractors. The behavior results in an endogenous downward shift in the distribution of bidders’ costs as the number of rivals increases, or the reservation price drops, unlike the case in the standard mechanism design model where the distribution of bidder’s private information is independent from such competitive environment variables. As a result of the theory, I demonstrate that the revenue maximizing reservation price is decreasing in the number of bidders. Furthermore, if the prime contractors’ endogenous participation in the procurement auction is taken into account, it is shown that subsidizing the potential bidders’ entry is a remedy to solve the double marginalization problem, allowing the auctioneer to extract more rents from subcontractors.

The final essay “Equilibria in Asymmetric Auctions with Entry” discusses an affiliated private value auction with entry. The contribution of this paper is to relax the symmetric assumption (i.e., the potential bidders may not be ex ante the same). The main findings are threefold. First, auction is optimal (revenue maximizing) if and only if the mechanism is ex post efficient. Second, without any participation control, a coordination problem in which only the lower value bidders participate and the higher value bidders stay out is likely, which makes the auctioneer worse off. Finally, there is an entry fee/subsidization scheme which, together with an ex post efficient mechanism, implements the optimal outcome as a unique equilibrium. Contrary to the existing theorem which claims that in asymmetric auctions well-designed ex post inefficient mechanisms are optimal (e.g., Myerson (1981), McAfee and McMillan (1987)), our results show that, even in an asymmetric auction, the mechanisms with free entry and no distortion are optimal taking into account the potential bidders endogenous participation.

Howard Marvel, P. (Committee Chair)
Lixin Ye (Committee Member)
Matthew Lewis, S. (Committee Member)
156 p.

Recommended Citations

Citations

  • Nakabayashi, J. (2009). Empirical and Theoretical Analysis of Public Procurement Auctions [Doctoral dissertation, Ohio State University]. OhioLINK Electronic Theses and Dissertations Center. http://rave.ohiolink.edu/etdc/view?acc_num=osu1243975511

    APA Style (7th edition)

  • Nakabayashi, Jun. Empirical and Theoretical Analysis of Public Procurement Auctions. 2009. Ohio State University, Doctoral dissertation. OhioLINK Electronic Theses and Dissertations Center, http://rave.ohiolink.edu/etdc/view?acc_num=osu1243975511.

    MLA Style (8th edition)

  • Nakabayashi, Jun. "Empirical and Theoretical Analysis of Public Procurement Auctions." Doctoral dissertation, Ohio State University, 2009. http://rave.ohiolink.edu/etdc/view?acc_num=osu1243975511

    Chicago Manual of Style (17th edition)