Economics Webinar - Secret Floor Price in Procurement Auctions

Contrary to the common belief that procurement auctions allocate contracts to the lowest competitive bid, real-world practices often diverge from this approach due to quality concerns. However, the implications of such practices on contract outcomes remain under-investigated. In this study, we examine the effects of secret floor price rules, which automatically disqualify bids below a certain threshold that is unknown to bidders at the time of bidding. We develop a model of a secret floor price auction and characterize the equilibrium bidding strategy. By leveraging the random nature of this auction rule, implemented by the Department of Land Development in Japan, we uncover how contract outcomes are associated with contractors’ costs.