Corruption-proof Contracts in Competitive Procurement

Transcription

1 Alessandro De Chiara and Luca Livio FNRS, ECARES - Université libre de Bruxelles APET Workshop Moreton Island - June 25-26, 2012

2 Introduction Introduction PFI, quality, and corruption PPPs are procurement contracts in which the supplier takes responsibility for both the building of the infrastructure and its management; In Private Finance Initiatives (PFIs), the users typically do not pay and it is the buyer who compensates the contractor for delivering and managing the good; PFI contracts are increasingly used in education, healthcare, and public safety (104 transactions in the last 2 years in Europe); Alessandro De Chiara and Luca Livio APET Workshop Moreton Island - June 25-26, / 38

3 Introduction Introduction PFI, quality, and corruption In procurement, we typically refer to quality as all the non-monetary attributes of a proposal (such as technological properties, design specication, etc.). Although the quality of a proposal is particularly important, its evaluation is not an easy task, especially in PFI contracts. Generally, two problems may arise: 1 the buyer may lack the skills to evaluate the quality of dierent proposals (ex-ante unobservability), and, once the good is delivered, quality is usually unveriable (ex-post unveriability); 2 the buyer may be unable to identify the rm which is the most ecient in delivering the desired quality. Alessandro De Chiara and Luca Livio APET Workshop Moreton Island - June 25-26, / 38

4 Introduction Introduction Quality signals Once the good is produced or the service provided, signals imperfectly correlated with quality become available; For instance, consider the UK experience of the Commission for Architecture and the Built Environment (CABE). It used the Design Quality Indicator to ex-post evaluate quality of projects provided through PFI, such as: secondary schools (CABE, 2006); health-care facilities (CABE, 2008); Alessandro De Chiara and Luca Livio APET Workshop Moreton Island - June 25-26, / 38

5 Introduction Introduction The signal-contingent contract Being veriable, these signals can be contracted upon. The principal can present the potential contractors with a signal-contingent contract; this contract must specify signal-contingent transfers that induce a contractor to provide the desired quality; as a result, the contractor bears the risk of an imperfect correlation between quality and its signals; this solution can be excessively costly for the buyer due to contractor's limited liablity, risk-aversion, etc.; furthermore, an ecient allocation of the contract may not be achieved. Alessandro De Chiara and Luca Livio APET Workshop Moreton Island - June 25-26, / 38

6 Introduction Introduction The auctioneer Alternatively, the buyer may hire an external expert, the auctioneer, who has the skills to assess quality. If the auctioneer's report is reliable, holding an auction: can reduce the cost of inducing the desired quality; ensures an ecient allocation of the contract. Alessandro De Chiara and Luca Livio APET Workshop Moreton Island - June 25-26, / 38

7 Introduction Introduction Corruption concerns However, delegation of quality assessment may lead to corruption concerns: on the one hand, the interested contractors are tempted to bribe the auctioneer to distort her assessment (bribery); when bribery occurs, the delivered quality is lower than the contracted one; on the other hand, the auctioneer may menace the contractor to misreport his proposal (framing/extortion); when extortion occurs, the incentives to provide the desired quality are lowered. Alessandro De Chiara and Luca Livio APET Workshop Moreton Island - June 25-26, / 38

8 Introduction Introduction Corruption concerns Corruption in procurement is a pressing problem (OECD report, 2010): in Europe, the cost increase due to corruption is likely to be around % of contract value (Eigen, 1997); this problem is at its most severe when the auctioneer can steer the contract to the colluding bidder at negligible cost (for anedoctal evidence, see Fite 1998); the theoretical literature recommends to lower the weight of quality in the scoring rule (Burguet and Che, 2004). Alessandro De Chiara and Luca Livio APET Workshop Moreton Island - June 25-26, / 38

9 Introduction Research Question In this paper: we study whether it is possible to address corruption when: the buyer has a quality concerns and the auctioneer can manipulate her assessment at zero cost; we study how the choice of the optimal award mechanism is aected by: the institutional strength of a country; the contractors' attitude towards risk; the competition intensity at the tender stage. Alessandro De Chiara and Luca Livio APET Workshop Moreton Island - June 25-26, / 38

10 Introduction Findings 1 We show that a corruption-proof auction can be obtained by making the auctioneer accountable for her report; this allows us to assign quality its optimal weight in the scoring rule; 2 we prove that such a procedure always guarantees an ecient allocation of the contract; Alessandro De Chiara and Luca Livio APET Workshop Moreton Island - June 25-26, / 38

11 The Model The Model The buyer We consider a framework in which a risk-neutral public authority (the buyer) wishes to procure a good from the outside: there are two specications of the good, which dier in terms of quality, q and q, q > q; quality enters linearly into the buyer's utility function. Alessandro De Chiara and Luca Livio APET Workshop Moreton Island - June 25-26, / 38

12 The Model The Model The potential contractors There are two potential, risk-neutral contractors, a and b: both are protected by limited liability and bear dierent cost of production; deliver high quality is always more expensive than deliver low quality, i.e., c i( q) > c j(q) for i, j {a, b}; q max i {a,b} c i( q) > q min i {a,b} c i(q); the prot of a rm i is given by: π i = t c i(q); Alessandro De Chiara and Luca Livio APET Workshop Moreton Island - June 25-26, / 38

13 The Model The Model The potential contractors Henceforth we focus on the case in which each rm is specialized in delivering a certain quality level: rm a is the most ecient in producing high quality, c a( q) < c b ( q); rm b is the most ecient in producing low quality, c b (q) < c a(q); as a result, c a < c b, where c i = c i( q) c i(q). Alessandro De Chiara and Luca Livio APET Workshop Moreton Island - June 25-26, / 38

14 The Model The Model Information structure The buyer: at the tender stage, he does not observe the quality of the submitted projects; ex-post, he can observe but he cannot verify quality; he never observes the rms' identities; Each rm: knows both its own production costs and those of its competitor; Alessandro De Chiara and Luca Livio APET Workshop Moreton Island - June 25-26, / 38

15 The Model The Model Quality observability and the Signal Once the good is delivered: a veriable signal s {l, h}, is drawn: P r[s = h q = q] = P r[s = l q = q] = γ > 1/2; P r[s = h q = q] = P r[s = l q = q] = 1 γ. Alessandro De Chiara and Luca Livio APET Workshop Moreton Island - June 25-26, / 38

16 The Model The Model Possible Solutions The presence of such a signal paves the way for two possible solutions: 1 a Corruption-proof auction (cpa): to obtain truthful reporting, the auctioneer's compensation is linked to her report and the signal realization; the auctioneer bears the ex-post risk of an imperfect correlation between q and s; 2 a Signal-contingent contract (scc): the principal dispenses with the auctioneer and pays the contractor signal-contingent payments; the contractor bears the ex-post risk. Alessandro De Chiara and Luca Livio APET Workshop Moreton Island - June 25-26, / 38

17 The signal-contingent contract The Signal-contingent Contract If the buyer decides to implement the scc, we observe the following timing: 1 the buyer announces the contingent transfers t and t he will pay to the selected contractor; 2 all the interested contractors may either accept or reject the oer. If only one of them accepts, he is automatically chosen as the contractor. If both accept, the awardee is randomly chosen; 3 the good is delivered; 4 the signal is drawn and the contractor receives a transfer. Alessandro De Chiara and Luca Livio APET Workshop Moreton Island - June 25-26, / 38

18 The signal-contingent contract The Signal-contingent Contract In practice, the buyer must determine the transfers t and t that ensure: the participation of at least rm a; that neither potential contractor accepts the contract and delivers low-quality. To this end, the principal has to impose the following constraints: γ t + (1 γ)t min ci( q) = ca( q), (PCa) i {a,b} (2γ 1)( t t) max c i = c b. i {a,b} (ICb) along with t 0 and t 0. Alessandro De Chiara and Luca Livio APET Workshop Moreton Island - June 25-26, / 38

19 The signal-contingent contract We need to distinguish between two cases: If c b < (2γ 1)ca( q), both (PCa) and (ICb) bind at the optimum. As a γ result, we obtain: t = c a( q) + 1 γ 2γ 1 c b, t = c a( q) γ 2γ 1 c b here, the expected cost for the buyer is E[T scc] = c a( q), which is smaller than E[T A] β [0, 1]. Conversely, if c b (2γ 1)ca( q), the non-negativity constraint associated to t binds γ along with (ICb). As a result: In this case, E[T scc] = t = c b (2γ 1), t = 0. γ (2γ 1) c b. Alessandro De Chiara and Luca Livio APET Workshop Moreton Island - June 25-26, / 38

20 The Corruption-proof Auction The Corruption-proof Auction When an auction is held to select the contractor, we need to introduce a new player: the auctioneer. The auctioneer is risk-neutral and wealth-constrained; she observes the quality of the proposals and sends a report ˆq {q, q} on the technical aspects of both projects; she receives a payment w, which is contingent on both the report and the signal; for instance, w h is the payment contingent on ˆq = q and s = h. Alessandro De Chiara and Luca Livio APET Workshop Moreton Island - June 25-26, / 38

21 The Corruption-proof Auction The Corruption-proof Auction Before sending her report, the auctioneer can sign a side-contract with either bidder. in the side-contract, the auctioneer commits to report the assessment {ˆq a, ˆq b } agreed upon with the colluding bidder; in exchange, she receives a side-transfer, which is paid if the contract is awarded to the colluding bidder; frictions due to transaction cost depreciate the side-transfer by a fraction (1 β); to focus on the worst possible scenario for the buyer, we assume that the auctioneer holds all the bargaining power at the side-contracting stage. Alessandro De Chiara and Luca Livio APET Workshop Moreton Island - June 25-26, / 38

22 The Corruption-proof Auction Timing The Corruption-proof Auction The Timing The timing is the following: 1 bidders simultaneously submit their bids, which consist of a technical oer and a requested price, b i = {q i, t i} i {a, b}; 2 the auctioneer observes the quality proposals and the bidders compete in bribes to obtain the auctioneer's favor. A side contract may be signed between one of the two bidders and the auctioneer; 3 the auctioneer sends a report ˆq i i {a, b} on the quality of the two proposals to the buyer; 4 the buyer compares the two bids, ˆb i = (ˆq i, t i), i {a, b}, and selects the highest score, according to the following rule: S i = ˆq i t i, i {a, b}. The winning bidder receives the asked price; 5 the good is delivered; 6 the signal is drawn and the auctioneer receives a transfer. Alessandro De Chiara and Luca Livio APET Workshop Moreton Island - June 25-26, / 38

23 The Corruption-proof Auction Ceiling prices and bargaining-powers The Corruption-proof Auction Some Remarks Remarks: 1 The buyer is reluctant to pay more than c b ( q) (respectively c a(q)) to obtain high (low) quality: therefore, he will rationally set a ceiling price to the maximum price he is willing to pay for any quality specication. 2 Both rms would be willing to deliver a low-quality good asking for a high-quality price. since c b (q) < c a(q) bidder b has an advantage in the competition for the auctioneer's favor; the highest bribe b can oer, c b, is strictly greater than the a's highest bribe, c b ( q) c a(q). Alessandro De Chiara and Luca Livio APET Workshop Moreton Island - June 25-26, / 38

24 The Corruption-proof Auction Ceiling prices and bargaining-powers The Corruption-proof Auction Proposition 1 Bidder b can ask the supervisor to over-report his quality and to under-report that of a in return for his extra-prot, c b ; if bidder a expects the quality of his proposal to be under-reported, he will submit q a = q; to prevent the auctioneer from over-report b's quality, the buyer has to set the following coalition incentive-compatibility constraint: γw l + (1 γ)w h }{{} E[w q b =q,ˆq b =q] γ w l + (1 γ) w h + β c b }{{} E[ w,β c b q b =q,ˆq b = q] (CIC1) for ˆq a = q a = q. As a result, it not rational for the auctioneer to report ˆq b = q when q b = q. Alessandro De Chiara and Luca Livio APET Workshop Moreton Island - June 25-26, / 38

25 The Corruption-proof Auction Ceiling prices and bargaining-powers A Corruption-proof Auction Proposition 1 Once (CIC1) holds, bidder b still has an incentive to bribe the auctioneer to under-report a's quality. in this case, the highest bribe b can oer is c = c a(q) c b (q); to prevent this collusive agreement, the buyer has to set the following coalition incentive-compatibility constraint: γ w h + (1 γ) w l γw }{{} l + (1 γ)w h + βc, (CIC2) }{{} E[ w q a= q,ˆq a= q] E[w,β c q a= q,ˆq a=q] for ˆq b = q b = q. If (CIC2) is fullled: it is rational for the auctioneer to downgrade a's quality; a will optimally submit q a = q. Alessandro De Chiara and Luca Livio APET Workshop Moreton Island - June 25-26, / 38

26 The Corruption-proof Auction Ceiling prices and bargaining-powers A Corruption-proof Auction Proposition 1 Theoretically, the auctioneer could threaten a to misreport quality in return for a positive amount of money (framing/extortion). She can menace a to: under-report the quality of a's proposals and/or over-report the quality of b's proposals; Because of (CIC1) and (CIC2), if a rejects any of these side-contracts, the auctioneer maximizes her utility by revealing truthfully the qualities of both proposals. Once bribery is defeated, any framing menace turns out to be empty. Alessandro De Chiara and Luca Livio APET Workshop Moreton Island - June 25-26, / 38

27 The Corruption-proof Auction Ceiling prices and bargaining-powers The Corruption-proof Auction Proposition 1 As a result, the following Proposition holds: Proposition 1 Any corruption attempt fails whenever (CIC1) and (CIC2) are satised. The quality of both proposals is truthfully reported by the auctioneer; bidder a wins the auction by submitting a bid {q a = q; t a = c b ( q) ε 0}, while b cannot ask less than t b = c b ( q). Alessandro De Chiara and Luca Livio APET Workshop Moreton Island - June 25-26, / 38

28 The Corruption-proof Auction Proposition 2 The Corruption-proof Auction Proposition 2 Proposition 2 To minimize the total expected cost of the corruption-proof auction, the buyer optimally sets: [ β (1 γ) w l = γ c + c b ] (2γ 1), w h = β [ c + c b], (2γ 1) and w h = w l = 0. As a result, the total expected cost of the cpa is given by: E[T A] = γβ[ c + c b] (2γ 1) + c b ( q). Alessandro De Chiara and Luca Livio APET Workshop Moreton Island - June 25-26, / 38

29 The Corruption-proof Auction Proposition 2 The Choice of the Selecting Device The following Proposition identies the values of β such that the cpa dominates the scc: Proposition 3 In presence of risk neutral rms, the buyer runs the corruption-proof auction if and only if β c b (2γ 1) c γ b ( q) = β c b + c Namely, the buyer runs the cpa if and only if the depreciation rate of the side-transfer is suciently high. Alessandro De Chiara and Luca Livio APET Workshop Moreton Island - June 25-26, / 38

30 The Corruption-proof Auction Proposition 2 The Choice of the Selecting Device Proposition 3 shows the relationship between c b and β. In general, we can conclude that if c b is suciently small only a is willing to participate in the scc; the scc always allocates the contract to the most ecient rm; the contractor bears the ex-post risk associated with the imperfect alignment between quality and its signal; On the other hand, if c b is suciently high, the scc does not guarantee that the contract is awarded to the most ecient rm; the cpa improves upon the scc provided that β is not too high; when this occurs, the ex-post risk is optimally shifted from the contractor to the auctioneer. Alessandro De Chiara and Luca Livio APET Workshop Moreton Island - June 25-26, / 38

31 The institutional strength The importance of the institutional framework In our model, (1 β) represents the exogenous depreciation-rate of the side-transfer; in reality, there are several, correlated, factors that impact on this parameter; In particular, it may be that the stronger the attitude of a country towards honest behavior: the higher the powers accorded to the judicial authorities; the harsher and more eective the punishments; the better the monitoring technologies employed to detect corruption; the higher the reputational concerns for the colluding players (psychological costs); the higher the cost of organizing illegal activities; Therefore, (1 β) represents a measure of the institutional strength of a country. Alessandro De Chiara and Luca Livio APET Workshop Moreton Island - June 25-26, / 38

32 Risk-averse Firms Risk-averse Firms In the scc the contractor may not receive any upfront payment before delivering the good (t = 0); this does not represent a problem, provided that: 1 rms are risk-neutral; 2 they have no diculty covering production costs. Nevertheless, very often PPP projects have a huge size and they take a large fraction of rms' activities; therefore, it would be dicult for a rm to share its risks optimally; by contrast, a professional auctioneer may be able to share risks better than a rm, by evaluating a portfolio of negatively-correlated projects. Alessandro De Chiara and Luca Livio APET Workshop Moreton Island - June 25-26, / 38

33 Risk-averse Firms Risk-averse Firms CARA utility function Therefore, it is of interest to analyze the case of risk-averse rms. Firms working in the same industry may have similar attitudes towards risk; we assume that both rms' preferences are represented by the same CARA utility function: u(t) = 1 [1 e r(t c)] r where r is the Arrow-Pratt coecient of absolute risk aversion. Alessandro De Chiara and Luca Livio APET Workshop Moreton Island - June 25-26, / 38

34 Risk-averse Firms Risk-averse Firms The impact of risk-aversion What changes with respect to the previous analysis are the transfers paid by the buyer in the scc: we can rewrite the threshold β as follows: β r = (2γ 1) γ where E[T scc] increases exponentially in r; E[T scc] c b ( q), c b + c when r > r, the cpa dominates the scc even if institutions are totally unable to detect corruption (β > 1); when r > r > r, it is not possible to obtain an high-quality project through the scc; where r and r are both functions of γ, c i(q) for all i {a, b} and q {q, q}. Alessandro De Chiara and Luca Livio APET Workshop Moreton Island - June 25-26, / 38

35 Multiple Bidders Multiple Bidders What is the impact of an increase in the number of potential contractors? Setting: n > 2 risk-neutral bidders. To simplify the analysis, c 1 < c 2 < < c n; Cpa: once truthful reporting is ensured, the winning bidder will ask for c 2( q) rather than the ceiling price, c n( q), cause of the presence of intermediate competitors; Scc: the expected transfer paid by the buyer will depends on the highest cost dierential, c n. As a result, the expected impact of an increase in the number of potential contractors is an improvement in the relative performance of the cpa. Alessandro De Chiara and Luca Livio APET Workshop Moreton Island - June 25-26, / 38

36 Conclusions Conclusions When a public authority has quality concerns, corruption is a pressing problem at the tender stage of a procurement auction: we have shown how to develop an auction mechanism which deters corruption even when there are no limit to the ability of the auctioneer to misreport quality; to do so, the auctioneer has to be held accountable for the content of her report; alternatively, the buyer can employ a signal-contingent contract to select the contractor; we have investigated the role played by the institutional strength, risk-aversion, and competition on the choice of the award mechanism. Alessandro De Chiara and Luca Livio APET Workshop Moreton Island - June 25-26, / 38

37 Conclusions Conclusions Policy recommendations In those countries where institutions are suciently strong, we recommend: to create a link between the auctioneer's assessment and her compensation. Delegation should be followed by an output-based compensation scheme. To encourage the collection of reliable data on the quality of infrastructures and services. The tasks of the project evaluation at the bidding stage and of judging their performance ex-post must be allocated to two dierent entities so as to preserve the trustworthiness of the quality signals. For similar reasons, it must not be the buyer to evaluate performance. Alessandro De Chiara and Luca Livio APET Workshop Moreton Island - June 25-26, / 38

38 Conclusions Related literature Bribery, extortion, and soft-information (Khalil et al. 2010), De Chiara and Livio (2012). Corruption in procurement (Burguet and Che, 2004, Laont and Tirole, 1991, Celentani and Ganuza, 2002). Institutional strength and ex-post corruption (Iossa and Martimort, 2011). Alessandro De Chiara and Luca Livio APET Workshop Moreton Island - June 25-26, / 38