Too Much Balance in Unbalanced Bidding

Abstract

This article adds to the theoretical base of unbalanced bidding in auction theory. The importance of this concept is justified by being a decisive feature in the make-or-buy decision of a client who cannot rely on repeated interaction, often the case in public procurement, for example. Earlier theoretical models on unbalanced bidding often predict corner solutions, that is, zero bids for unit prices of expected overestimated quantities. However, anecdotal evidence indicates a lack of zero bids in the actual contracts. The article offers a possible explanation for this anomaly by focusing on the risk-aversion of the contractor. Using a simple model, it shows that a contractor with superior information may exploit this in the bidding process to increase her expected revenue. This increases risk exposure. A risk-averse contractor will typically avoid a corner solution to reach an optimal balance between risk and expected return.