Sequential Procurement Auctions with Risk-Averse Suppliers

Abstract

We compare two procurement mechanisms, bundling and unbundling, in a two-stage auction model with risk-averse suppliers. They differ in whether two sequential tasks of investment and production are procured through a single auction or two sequential auctions. Each auction adopts a first-price format. A winner is awarded a fixed-price contract. Each supplier's production cost is affected by two risk factors, aggregate risk and idiosyncratic risk, as well as the cost-reducing investment. The aggregate risk is common to all suppliers, but the idiosyncratic risk is specific to each supplier. A risk-neutral buyer trades off risk sharing, incentive provision, and ex post efficiency of contract allocation. Our main result shows that an increase in the aggregate risk renders bundling less preferable to unbundling, from the viewpoint of both the buyer and the society. The result still holds even if subcontracting is possible under bundling. On the other hand, an increase in the idiosyncratic risk does not necessarily render bundling less preferable to unbundling.