Collusion and Optimal Reserve Prices in Repeated Procurement Auctions

Authors:
Charles J. Thomas
Working Paper:
242

Previous research on collusion in procurement markets uses static mechanism design theory to address the limitations on collusive activity imposed by asymmetric information, but in most instances it does not address how to enforce the proposed mechanisms. This paper uses repeated game theory to examine the sustainability of two commonly reported collusive schemes that have been identified as optimal static mechanisms. If a buyer does not select its reserve price strategically, or if its value is large relative to the sellers' costs, then collusion may be sustainable for a wide range of plausible discount factors. However, even mildly sophisticated reserve price selection can dramatically shrink the set of discount factors for which collusion can be sustained. These findings provide a rationale for existing arguments that buyers are vulnerable to collusion, but suggest that buyers possess tools that may profitably induce sellers to act competitively. The analysis also reveals that collusion tends to be more easily sustained if the sellers' costs have a low mean or a high variance, or, in some instances, if the number of sellers increases.