Wild bids. Gambling for resurrection in procurement contracts

This paper analyzes the problem of abnormally low tenders in theprocurement process. Limited liability causes firms in a bad financialsituation to bid more aggressively than good firms in the procurementauction. Therefore, it is more likely that the winning firm is a firm infinancial difficulties with a high risk of bankruptcy. The paper analyzesthe different regulatory practices to face this problem with a specialemphasis on surety bonds used e.g. in the US. We characterize the optimalsurety bond and show that it does not coincide with the current USregulation. In particular we show that under a natural assumption the USregulation is too expensive and provides overinsurance to the problem ofabnormally low tenders.