Incentive Contracts, Adverse Selection, and Risk Transfer : Evidence from Procurement

Multi-attribute auctions, designed to address multi-dimensional preference, make a good casestudy where incentive provisions interact with competition. By studying "Cost Time" highwayprocurement that aims to incentivize timely project delivery, we show that awarding incentivecontracts by bidding mechanisms can yield sub-optimal outcomes. Our theory demonstratesthat bidders, facing high-powered incentives and production uncertainty, optimally skew theirtime bids while transferring production risk to buying agencies. This gaming behavior leads toadverse selection and efficiency loss, in that a less-efficient bidder can outbid the efficient bidderdue to the misalignment between bidder types and the auction rule that determines winners.We estimate our model using data from the California Department of Transportation and findthat 18% of auctions are allocated to inefficient bidders. Counterfactual analyses suggest thatprocurement schemes with lower incentives can yield less mis-allocation with lower productioncosts and less buyer budget pressure