We use data from highway procurement auctions subject to California's Small Business Preference program to study the effect of bid preferences on auction outcomes. Our analysis is based on an estimated model of firms' bidding and participation decisions, which allows us to evaluate the effects of current and alternative policy designs. We show that incorporating participation responses significantly alters the assessment of preferential treatment policies.Keywords: Bid preference programs, auction participation, asymmetric bidders. JEL Classification: D44, L10, H11, H571 Introduction Public-sector procurement accounts for over 10% of U.S. GDP. Across levels of government, preferential treatment programs are extensively used in procurement auctions. For example, in 2006, the federal government awarded 20% of its procurement dollars to favored firms. 1One commonly used preference mechanism, a bid discount or credit, improves the bids of favored firms by a pre-established rate when determining the winner, but uses the actual amount of the winner's bid in the contract. 2Prominent examples include a 25% bid credit granted to small firms in FCC spectrum auctions and a 50% bid penalty added to foreign bids on defense contracts. 3The aim of this paper is to improve our understanding of the effects of such preference programs on the government's cost of procurement and the distribution of profits between participants, as well as to provide an assessment of the likely magnitudes of these effects in practice. We do so empirically in the context of the California Small Business Preference program that grants small firms a 5% bid discount. 4The stated goal of most preference programs is to facilitate the integration of favored participants into the market place. These are often groups historically discriminated against, or groups considered disadvantaged due to entry barriers, or both. They are also often considered to be less cost efficient. As preference programs result in such high-cost companies performing a larger share of work, one may expect the cost of procurement to increase. At the same time, however, these programs also provide incentives to non-favored firms to bid more aggressively against the strengthened favored group, which mitigates the upward pressure on the cost of procurement. For some discount levels, this last effect is sufficiently strong for the cost of procurement to actually decrease (McAfee and McMillan (1989) and Corns and Schotter (1999) show this theoretically and in experiments, respectively, for assumed numbers of bidders and cost distributions).The key insight of this paper is that there is a third effect neglected in the literature. Bid preference programs have potentially strong effects on firms' incentives to participate in 1 See the Federal Procurement Report 2007, available at https://www.fpds.gov/. 2 With a 10% bid discount, for example, a bid by a favored firm of $440,000 is treated as a bid of $400,000 in comparing it to the remaining, non-favored, firms' bids. If the favor...

This paper proposes a semi-parametric method to uncover the distribution of bidders' private information in the market for highway procurement when unobserved auction heterogeneity is present. I derive sufficient conditions under which the model is identified and show that the estimation procedure produces uniformly consistent estimators of the distributions in question. The estimation procedure is applied to data from Michigan highway procurement auctions. I estimate that 75% of the variation in bidders' costs may be attributed to the factors known to all bidders and only 25% may be generated by private information. My results suggest that failing to account for unobserved auction heterogeneity may lead to overestimating uncertainty that bidders face when submitting their bids. As a result both inefficiency of the auction mechanism and markups over the bidders' costs may be overestimated.

This article provides evidence on the role of subcontracting in the auction‐based procurement setting with private cost variability and capacity constraints. We demonstrate that subcontracting allows bidders to modify their costs realizations in a given auction as well as to control their future costs by reducing backlog accumulation. Restricting access to subcontracting raises procurement costs for an individual project by 12% and reduces the number of projects completed in equilibrium by 20%. The article explains methodological and market design implications of subcontracting availability.

This paper investigates theempirical importance of allowing for multi-dimensional sources of unobserved heterogeneity in auction models with private information. It in turn develops the estimation procedure that recovers the distribution of private information in the presence of two distinct sources of unobserved heterogeneity. It is shown that this estimation procedure identifies components of the model and produces uniformly consistent estimators of these components. The estimation procedure is applied to the data from highway procurement. The results of the estimation indicate that allowing for two-dimensional unobserved heterogeneity may significantly affect the results of estimation as well as policy-relevant instruments derived from the estimated distributions of bidders' costs.

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