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This paper investigates tenderers' behaviors in one-shot construction bid auctions. The model formulated in this paper generalizes competitive sealed-bid auction theories by allowing different risk preferences and predicts price quoting behaviors of different tenderers in the tendering process. The model theoretically suggests that a tenderer's bid is affected by his risk preference. Specifically, in a lowest-price sealed bid process, risk-averse tenderers tend to quote a higher price, risk-seeking tenderers a lower price, and risk-neutral tenderers an average price. Therefore, risk-seeking tenderers are more likely to win the bid.
Competitive sealed-bid auctions are commonly used in the construction industry. There are three basic rules that govern the bid process. First, all qualified tenderers quote with sealed prices. Second, bids must be submitted by a fixed deadline and opened publicly. Third, the lowest-price or the second lowest-price tenderer wins the bid. Previous studies suggest that the sale objects in most auctions possess both private and public values (e.g., Goeree and Offerman, 2002 and 2003; Klemperer, 1999; and Laffont, 1997). For construction projects, Dyer and Kagel (1996) argue that bidding is usually treated as a public value auction.
What makes the auction interesting is that bidders have different estimates of the true cost at the time they bid. If bids decrease with decreasing cost estimates, the low-price bidder faces an adverse selection problem, as he wins only when he has one of the lowest estimates of construction cost. Unless this adverse selection problem is accounted for in bidding, the low-price bidder is likely to suffer from a `winner's curse', Which means that the winner of the contract actually makes below normal or even negative profits. |
