Bid Preference Programs and Participation in Highway Procurement Auctions

We use highway procurement auction data to analyze the California Small Business program that awards a contract to a qualified small bidder provided its bid is within five percent of the overall low bid. We study the effect of this rule on bidders’ incentives to participate in procurement auctions and compute its implied efficiency and distributional costs. Small bidder can use the discount to improve both his mark-up and the probability of winning the project. The last effect dominates at the upper end of the support where small bidders use the cushion of the discount to squeeze out larger bidders with high costs. This effect is, in general, stronger when distributions of project costs differ substantially across groups of bidders. We estimate a model of participation and bidding under the assumptions that (1) bidders make participation decisions before they observe their cost of completing the project; (2) bidders have to incur entry cost in order to participate in the auction; (3) bidders observe the number of their actual competitors at the time they submit their bid. Our estimation results imply that small bidders have on average higher cost of completing the project and higher cost of entering the project. The differences in the cost of entry are larger in the magnitude. These differences increase with the size of the project. In this environment, the program produces substantial increase in small bidders’ probability of winning and participation while resulting in a small change in the cost of the procurement to the government. The magnitudes of the effects and the sign of the effect on the cost of the procurement differ across project sizes.