Risky procurement with an insider bidder

Abstract

Procurement auctions carry substantial risk when the value of the project is highly uncertain and known only to insiders. This paper reports the results from a series of experiments comparing the performance of three auction formats in such complex and risky settings. In the experiment, every bidder knows the private value for the project but only a single insider bidder knows the common-value part. In addition to the standard second-price and English auctions we test the “qualifying auction,” a two-stage format commonly used in the sale of complex and risky assets. The qualifying auction has a fully “revealing” equilibrium that implements the revenue-maximizing outcome but it also has an uninformative “babbling” equilibrium in which bidders place arbitrarily high bids in the first stage. In the experiments, the latter equilibrium has more drawing power, which causes the qualifying auction to perform worse than the English auction and only slightly better than a sealed-bid second-price auction. Compared to the two other formats, the English auction is roughly 40% more efficient, yields 50% more revenues, avoids windfall profits for the insider, while protecting uninformed bidders from losses.