In this paper, we investigate the interaction between two firms, which are involved in a repeated procurement relationship modeled as a multiple criteria auction, and an auctioneer (a government employee) who has discretion in devising the selection criteria. Our main result is that favoritism substantially facilitates collusion. It increases the gains from collusion and contributes to solving basic implementation problems for a cartel of bidders operating in a stochastically changing environment. A most simple allocation rule where firms take turns in winning, independently of stochastic social preferences and firms’ costs, achieves full cartel efficiency (including price, production, and design efficiency). In each period the selection criteria is fine-tailored to the in-turn winner: the “environment” adapts to the cartel. This result holds true when the expected punishment is a fixed cost. When the cost varies with the magnitude of the distortion of the selection criteria (compared to the true social preferences), favoritism only partially shelters the cartel from the environment. We thus find that favoritism generally facilitates collusion at a high cost for society. Our analysis suggests some anti-corruption measures that could be effective in curbing favoritism and collusion in public markets. It also suggests that the much-advocated rotation of officials is likely to be counter-productive.
Review of Industrial Organization – Springer Journals
Published: Oct 14, 2009
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