Testing Vickery’s Revenue Equivalence Theory in Construction Auctions

Abstract

Construction work is often allocated to contractors via first price sealed bid auctions (FPA). American Nobel Prize winner and economist William Vickery, however, suggested that second price auctions (SPA) (i.e., the lowest bidder wins the contract at the second lowest price) may be more beneficial due to the revenue equivalence theory (RET). This implies that, upon certain conditions being met, clients can, in the long run, expect to pay approximately the same to contractors irrespective of whether contracts are awarded according to an FPA or SPA. At the same time, it is expected to be easier to bid in an SPA. In the absence of real world data, the likely effects of using SPA for construction were examined experimentally. This involved experienced respondents bidding on over 60 identical FPA and SPA. Contrary to expectations, the bids for the SPA were significantly higher, indicating that RET is unlikely to occur in practice in construction bidding.