Cost Overruns, Winner's Curse, Wisdom of the Crowd, and a Pendulum Effect in Public Construction Tenders

Abstract

The “wisdom of the crowd” is a concept that argues that collective opinion is better than any single (even expert) opinion. The wisdom of the crowd has a particularly important implication in tenders. Consider the scenario of project bidding, where multiple contractors bid for a contract and the winner is the bidder committing for the lowest cost. If the collective bid, i.e., the average bid, is the most accurate in assessing the true value of the contract, then the winning bid is underestimating the contract and therefore is expected to end up with a loss, a result known as the “winner's curse”. While this outcome predicts that project owners will save costs it is hardly so, as cost overruns are ubiquitous in the construction industry. In this paper, we analyzed the cost estimates, contractors' bids and total payments of 148 government tenders of construction projects. We identified and quantified the three aforementioned phenomena: the wisdom of the crowd, the winner's curse and cost overruns. Considered together, these phenomena manifest a pendulum effect in which the auction winning contractor pendulates from a cursed to a blessed state, at the expense of the public's interest.