Multidimensional Auctions for Long-Term Procurement Contracts with Early-Exit Options: The Case of Conservation Contracts. European Journal of Operational Research, Volume 267, Issue 1, pp. 368-380.
Conservation contracts, aimed at encouraging preservation and maintenance of natural areas, generally involve long-term obligations. Yet, contractors can find it profitable to breach the agreement when the opportunity cost of keeping their land idle for environmental purposes increases, and contracts do not provide for adequate early termination penalties. In this paper, we study how exit options can affect bidding behavior and the buyer’s and the seller’s expected payoffs in multidimensional procurement auctions. First, we show that bidders’ payoff is lower when competing for contracts with unenforceable contract terms. Second, we show that neglecting the risk of opportunistic behavior by sellers can lead to contract awards that do not maximize the buyer’s potential payoff. Third, we make suggestions about how to mitigate potential misallocations by pointing out the role of eligibility rules and competition among bidders.