Construction Bidding and the Winner’s Curse: Game Theory Approach

Abstract

AbstractIn the construction industry, competitive bidding has long been used as a method for contractor selection. Because the true cost of construction is not known until the completion of the project, adverse selection is a major concern. Adverse selection is when the winner of the contract has underestimated the project’s true cost. Thus, the winning contractor will most likely earn negative or at least below normal profits. The winner’s curse is when the winning bidder submits an underestimated bid and is thus cursed by being selected to undertake the project. In the multistage bidding environment, where subcontractors are hired by a general contractor, the winner’s curse may be compounded. In general, contractors suffer from the winner’s curse for a variety of reasons including inaccurate estimates of project cost; new contractors entering the construction market; minimizing losses in case of recession of the construction industry; strong competition within the construction market; differential oppor...