Optimality of simple procurement auctions

We consider procurement auctions for the projects where the cost of production is subject to ex-post shocks—cost overruns. The contractor may default due to these overruns, which affects the buyer’s expected cost. Here the lowest-bid auction emerges as the procurement mechanism that: (i) minimizes the expected transfers to the contractors, and (ii) requires the lowest surety bond to achieve a given probability of default. Since surety bonds are...