Ex-ante Investment and Stochastic Quality in Procurement Auctions

Abstract

This study examines procurement auction with ex-ante identical firms. The buyer wishes to procure an innovation, the quality of which stochastically depends on firms’ effort level. We analyze firms’ optimal investment and bidding strategies and show that the buyer’s payoff is non-monotone for the number of firms in the auction. We show that the buyer benefits with many firms when the probabilities of high quality from different investment levels are close to each other or the cost of high effort is sufficiently large or small. We also identify conditions under which the buyer benefits with less number of firms.