Working Paper: CEPR ID: DP10284
Authors: Fabian Herweg; Klaus M. Schmidt
Abstract: For the procurement of complex goods the early exchange of information is important to avoid costly renegotiation ex post. We show that this is achieved by bilateral negotiations but not by auctions. Negotiations strictly outperforms auctions if sellers are likely to have superior information about possible design improvements, if renegotiation is costly, and if the buyer's bargaining position is sufficiently strong. Moreover, we show that negotiations provide stronger incentives for sellers to investigate possible design improvements than auctions. This provides an explanation for the widespread use of negotiations as a procurement mechanism in private industry.
Keywords: adaptation costs; auctions; behavioral contract theory; loss aversion; negotiations; procurement; renegotiations
JEL Codes: D03; D82; D83; H57
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| procurement mechanism (negotiation vs. auction) (H57) | efficiency of the procurement process (H57) |
| negotiations (F51) | reduction in costly renegotiation (D23) |
| costly renegotiation (D23) | inefficiencies (avoided in negotiations) (D61) |
| negotiations (F51) | stronger incentives for sellers to invest in finding project improvements (O31) |
| auctions (D44) | discouraged investment by sellers (G24) |
| negotiations (F51) | higher probability of implementing design improvements (L15) |