Contracting for Infrastructure Projects as Credence Goods

Large infrastructure projects are a major responsibility of urban and regional governments, who usually lack expertise to fully specify the demanded projects. Contractors, typically experts on such projects due to experience with similar projects, advise of the needed design as well as the cost of construction in their bids. Producing the right design is costly. We model such infrastructure projects taking into account their credence goods feature and the costly design effort they require and examine the performance of commonly used contracting methods. We show that when building costs are homogeneous and public information, simultaneous bidding involving shortlisting of two contractors and contingent compensation of both contractors on design efforts outperforms sequential search. If building costs are private information of the contractors and are revealed to them after design cost is sunk, sequential search may be superior to simultaneous bidding.