Procuring a Good of an Improved Design

We solve for the optimal Bayesian procurement mechanism that implements the efficient allocation in a situation where sellers have two-dimensional private information.

Next to being privately informed about the cost, a seller may privately observe a flaw in the design proposed by the buyer. Sellers are protected by limited liability and their “flaw types” are positively correlated. The optimal mechanism uses as punishment the rents obtained from reporting the cost truthfully. This allows to reduce the information rent that is obtained by a seller who reports a flaw. We compare the optimal Bayesian mechanism with the (much simpler) optimal ex post incentive compatible mechanism.