Can Entry Mitigate the Effect of Inflated Reserve Prices in Public Procurement?

Abstract: Using data from drug procurement auctions in Russia and exploiting exogenous variation induced by two natural experiments, this paper first studies whether bureaucrats abuse their discretionary power when setting the reserve price: the maximum per unit price the government is willing to pay for a given drug. It then asks whether even in the environment characterized by a significant discretionary power of bureaucrats sufficient entry of firms can undo effects of discretion. Obtained results show that reserve prices are at least 8% too high as compared to the optimum: buyers could lower them by this amount, enjoying a one to one decrease in the final price with no increase in the probability of trade not happening. The second set of results indicates that entry can solve the problem of inflated reserve prices: an additional bidder causes prices to de- crease by around 8% to 9%. This effect is highly nonlinear: having more than one bidder versus one bidder causes prices to decrease by around 15% to 18%. Therefore my results suggest that even in an environment where reserve prices are inflated the legislator can undo these effects by ensuring that there are at least 2 participants in a procurement auction.