Economics serving society

On discrimination in auctions with endogenous entry

Philippe Jehiel and Laurent Lamy

Auction theory provides us with a theoretical framework for assessing the potential benefits of favouring tender bids by domestic firms over foreign companies. Roger Myerson (2007 Nobel Prize winner) contributed to the theory of mechanism design the hypothesis that a decision by a firm to respond to a call for tenders is made independently of the mechanism proposed. He established that if the sponsor’s goal is to minimise costs, then a bias in favour of domestic companies is justified if those firms are a priori less efficient than foreign firms. Indeed, such a bias tends to restore equilibrium to the conditions of competition in the market allocation mechanism, which leads to a reduction in the final price of the service – even if the service provider is not necessarily the most efficient.
But the participation of a firm in an market allocation mechanism has a cost that can be a barrier to its response to an appeal for tender bids. The question then arises about the best ways to attract the best possible profile of companies. Should the participation of less competitive companies be favoured through, for example, skewing the tender procedure? And if domestic firms participate anyway (their opportunity costs being the lowest), should the auction process be biased to attract other bidders, and if so, how?
In this article, Jehiel and Lamy respond to these questions by showing that there should be no positive discrimination towards firms that do not participate (let’s say, foreign companies), regardless of their efficiency. On the contrary, the authors establish that the auction should be biased against firms that participate systematically (say, domestic firms). Moreover, this bias should be introduced even if the objective internalises part of the profits of the latter and even if these firms are a priori less efficient than the others. The contrast of these results with those of Myerson reflects the profound effect of the endogenous nature of participation on the evaluation of policies of discrimination in awarding contracts.
Original title of the article : “On discrimination in auctions with endogenous entry”
Published in : January 2014 - CEPR Discussion Paper N° DP9790
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