Is more competition always desirable? - Evidence from public construction procurements in Finland

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Volume Title
School of Business | Master's thesis
Date
2015
Major/Subject
Finance
Rahoitus
Mcode
Degree programme
Language
en
Pages
97
Series
Abstract
RESEARCH PROBLEM: Researchers have found mixed evidence of how the level of competition affects bids in auctions. According to conventional economic theory, an increase in competition should make bids more competitive. However, the winner's curse phenomenon calls for less aggressive bids in common-value auctions. Bidders may become less aggressive also due to the entry effect, since an increase in the number of potential bidders decreases the likelihood of winning the contract, yet participation costs remain constant. Rational bidders should take this into account by bidding less aggressively. Which of the effect dominates differs between different types of auctions. DATA AND METHODOLOGY: In this thesis, was empirically studied using Finnish data, how the level of competition affects bids in auctions for public construction projects. Moreover, the relation between bid prices and budget overruns was also studied. The data for studying the effect of competition on bid prices contained information of 496 auctions of various kinds of projects, whereas the data for studying budget overruns contained information of 183 auctions. The data was analyzed using statistical methods such as multivariate regression analysis. The competitiveness of bids was measured as the relation between the pre-bid cost estimation and the lowest bid. Budget overruns were measured as the difference between the final cost of the contract and the lowest bid relative to the lowest bid. If the final cost of the project was not available, the relative amount of change orders and extra works was used as a proxy for budget overruns. FINDINGS: Per each additional bid received, the lowest bid decreases significantly when compared with the pre-bid cost estimation. However, the winner's curse and the entry effect significantly impact bids upward. Two solutions were provided: the release of information about the pre-bid cost estimation and the use of the second-price sealed-bid auction method. An economic downturn was found to be associated with the higher number of bids, lower bid volatility and more competitive bids. The timing of procurement is therefore important. Larger contracts were found to be associated with more accurate pre-bid cost estimations. The costs of small contracts are estimated roughly, but conservatively to avoid budget overruns. Bids were moreover found to be negatively correlated with budget overruns.
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Keywords
common-value auction, private-value auction, affiliated-value auction, winner’s curse, entry effect, budget overrun, public procurement, construction project
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