Reserve Price Underpricing As a Corrupt Strategy

Abstract: We model a sophisticated form of reserve price underpricing in public procurement and provide evidence for the existence of this corrupt equilibrium in Russian public procurement. Setting the reserve price at a relatively low level can prevent the waste of government funds and may discourage inefficient firms from participating. We however show theoretically that, given the right conditions and market structure, reserve price underpricing may also be a corrupt equilibrium that makes the corrupt procurer-seller pair better off. Moreover, this equilibrium can be sustained without side-payments. Our data analysis reveals that this strategy is also applied in Russian public procurement auctions. We indeed find cases of underpricing which are characterized by less competition and an increased likelihood of having only one bidder. Corrupt sellers are also more likely to win auctions and there often, but not always, still is a small rebate, as predicted by the model.