CFDP 1276

Investment Incentives in Procurement Auctions


Publication Date: September 2000

Pages: 41


We investigate firms’ incentives for cost reduction in the first price sealed bid auction, a format largely used for procurement. A central feature of the model is that we allow firms to be heterogeneous. Though private value first price auctions are not games with monotonic best responses, we find that for comparative statics purposes they behave like these games. In particular, firms will tend to underinvest in cost reduction because they anticipate fiercer head-on competition. Using the second price auction as a benchmark, we also find that the first price auction will elicit less investment from market participants. Moreover, both auction formats tend to favor investment by the current market leader and are therefore likely to reinforce asymmetries among market participants.


Asymmetric auctions, endogenous distributions, investment incentives

JEL Classification Codes:  C72, D44, L13


Published in Review of Economic Studies (January 2004), 71(1): 1-18 [DOI]