Selective Entry in Highway Procurement Auctions
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Selective Entry in Highway Procurement Auctions Sabrina Peng 1
# International Atlantic Economic Society 2020
Abstract When participating in an auction is costly, a potential bidder has to decide whether to enter the auction or not. The extent to which the potential bidders know their private cost before making their entry decisions determines how selective the entry process is. Endogenous selective entry is common in many auctions and it has important implications for designing auctions, in particular, choosing the bid discount policy that is frequently used in public procurements to achieve distributional goals of the government. Prior empirical studies of the bid preferences were based on frameworks that either did not explicitly model endogenous participation or assumed endogenous, but non-selective participation. This study empirically investigated whether the entry process is selective in the highway procurement auctions run by the California Department of Transportation. To this end, the asymmetric affiliated-signal model was adapted to permit endogenous selective entry. Model parameters, including entry costs and distributions of construction costs for regular and fringe companies, were estimated nonparametrically. The results show evidence favoring selective entry of the fringe firms and imply that the level of bid discount required to achieve the procurement buyer’s policy objective may be lower than what is previously found in the literature under the assumption of non-selective entry. Keywords Procurement auctions . Endogenous entry . Selection . Bid discount policy JEL D44 . H57 . L74
Introduction In public procurement, bid discount is a policy commonly used by government agencies to promote domestic, local or small firms and companies located in
* Sabrina Peng [email protected]
1
Department of Economics, University of Virginia, Charlottesville, VA, USA
Peng S.
economically disadvantaged areas, or owned by minority groups. The bid discount policy awards a contract to the favored firm when its bid is within a certain percentage of the lowest bid among the unfavored firms. This rule does not change the price of the contract, which is the winner’s bid. When bidder participation is endogenous and possibly selective, whether there is selection and how selective the entry process is have potentially strong effects on the optimal level of bid discount. For example, Sweeting and Bhattacharya (2015) showed that a seller’s revenue-maximizing bid discount level can vary from 2.5 to 12.5% depending on the degree of selection. A weaker player’s probability of winning increases with the degree of selection. In the existing literature, bid-preference programs have been studied under either exogenous entry (Marion 2007) or endogenous but non-selective entry (Krasnokutskaya and Seim 2011) models. Incorrectly assuming non-selection may lead to incorrect estimates of model primitives (Roberts and Sweeting 2010) which in turn bias the policy recommendation, in this case evaluations of bid-preference programs. Th
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