Testing Vickery's revenue equivalence theory in construction auctions

Abstract

Construction work is often allocated to contractors via first price sealed bid auctions. American Nobel Prize winner and Economist William Vickery, however, has suggested that a second price auction (lowest bidder wins the contract at the second lowest price) may be more beneficial to those concerned due to the revenue equivalence theory (RET). This implies that, upon certain conditions being met, owners can, in the long run, expect to pay approximately the same amount to contractors irrespective of whether contracts are awarded according to a first price auction (FPA) or second price auction (SPA). At the same time, it is expected to be easier to bid in a SPA.

In the absence of any real world data, the likely effects of using SPA for construction were examined experimentally. This involved the participation of a group of experienced construction bidders over 60 identical first and second price construction auctions. Contrary to expectations, the bids for the second price arrangement were significantly higher, indicating that RET is unlikely to occur in practice in construction bidding. In other words, the results indicate that construction clients are likely to pay more if second price auctioning is used in the construction industry.