In the presence of cost uncertainty, limited liability introduces the possibility of default in procurement with its associated bankruptcy costs. When …nancial soundness is not perfectly observable, we show that incentive compatibility implies that …nancially less sound contractors are selected with higher probability in any feasible mechanism. Informational rents are associated with unsound …nancial situations. By selecting the …nancially weakest contractor, stronger price competition (auctions) may not only increase the probability of default but also expected rents. Thus, weak conditions are su ¢ cient for auctions to be suboptimal. In particular, we show that pooling …rms with higher assets may reduce the cost of procurement even when default is costless for the sponsor
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