Strategic Design under Uncertain Evaluations: Theory and Evidence from Design-Build Auctions

This paper investigates firms’ competition over price and product design in the context of DesignBuild (DB) procurement auctions. In a DB auction, bidders submit both a price and a design proposal for a public infrastructure project. Each reviewer for the auctioneer (the government) independently evaluates and assigns a score to every design bid. The bidder with the lowest price per design score wins, and receives its price bid upon completion of the project. Data on DB auctions from the Florida Department of Transportation reveal substantial disagreements in reviewers’ evaluations of the same design. I argue that this discrepancy in evaluations is unknown to bidders at the time of making their bids. I develop and estimate a structural model of firm competition that incorporates uncertainty in design evaluations, introducing an element of luck in selecting the winner of a project. Based on the estimated model, I show that uncertain design evaluation induces more (respectively, less) competitive bidding by low (high) cost bidders, exacerbating uncertainty in both the winning price and design quality. I propose a second-price auction in which a bidder’s design score determines the transfer amount, shutting down the impact of uncertain evaluations on bidders’ behaviour through the winner selection process. I find that the alternative mechanism reduces the auctioneer’s uncertainty in both the amount paid and the quality of the winning design by 40% and 60%, respectively. ∗I am indebted to Victor Aguirregabiria for invaluable advice and generous guidance. I would also like to thank Ettore Damiano, Rahul Deb, Yao Luo, Robert McMillan, Xianwen Shi, Junichi Suzuki, Yuanyuan Wan, and the participants in CEPR/JIE, EARIE, and Jornadas de Economı́a Industrial for helpful comments. Thanks to Daniel Garcia and Andrea Pozzi for extensive discussions. All errors are mine. Email: [email protected]