Bidding for Incomplete Contracts: An Empirical Analysis of Adaptation Costs∗

Procurement contracts are often renegotiated because of changes that are required after their execution. Using highway paving contracts we show that renegotiation imposes significant adaptation costs. Reduced form regressions suggest that bidders respond strategically to contractual incompleteness and that adaptation costs are an important determinant of their bids. A structural empirical model compares adaptation costs to bidder markups and shows that adaptation costs account for 8-14 percent of the winning bid. Markups from private information and market power, the focus of much of the auctions literature, are much smaller by comparison. Implications for government procurement are discussed. JEL classifications: D23, D82, H57, L14, L22, L74. ∗We thank Liran Einav, Phil Haile, Igal Hendel, Ali Hortacsu, Tom Hubbard, Jon Levin and especially Ken Hendricks, Han Hong and Harry Paarsch for helpful discussions. We are grateful for financial support from the National Science Foundation.