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Unsustainability Risk of Bid Bonds in Public Tenders

Author

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  • Jacopo Giacomelli

    (SACE S.p.A-Piazza Poli 42, 00187 Rome, Italy
    Department of Statistics, Sapienza University of Rome, Viale Regina Elena 295, 00161 Rome, Italy)

  • Luca Passalacqua

    (Department of Statistics, Sapienza University of Rome, Viale Regina Elena 295, 00161 Rome, Italy)

Abstract

Public works contracts are commonly priced and awarded through a tender process. Each bidder joining the tender must underwrite a bid bond that guarantees their fitness as contractors in case of a win. The winning contractor also needs to underwrite a performance bond before entering the contract to protect the procuring entity against the performance risk arising during the execution phase. This study addresses the case when sureties refuse to issue the performance bond, despite having issued a bid bond to the same subject. A creditworthiness variation of the contractor during the tender or an excessive discount of the contract’s price may lead to this outcome. In that case, all the subjects involved are damaged. The surety who issued the bid bond has to indemnify the procuring entity. The contract award is nullified, which is financially harmful to both the contractor and the procuring entity. We show that sureties adopting a forward-looking risk appetite framework may prevent the demand for unsustainable performance bonds instead of addressing it by rejecting the bidders’ requests. The Solvency II regulatory framework, the Italian bidding law, and actual historical data available from the Italian construction sector are considered to specify a simplified model. The probability of unsustainable tender outcomes is numerically estimated by the model, together with the mitigating impact of a surety’s proper strategy.

Suggested Citation

  • Jacopo Giacomelli & Luca Passalacqua, 2021. "Unsustainability Risk of Bid Bonds in Public Tenders," Mathematics, MDPI, vol. 9(19), pages 1-21, September.
    • Handle: RePEc:gam:jmathe:v:9:y:2021:i:19:p:2385-:d:642880
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    References listed on IDEAS

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    4. Achim Wambach & Andreas R Engel, 2011. "Surety Bonds with Fair and Unfair Pricing," The Geneva Risk and Insurance Review, Palgrave Macmillan;International Association for the Study of Insurance Economics (The Geneva Association), vol. 36(1), pages 36-50, June.
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