IPPC6

1. <IPPC２０１４：Parallel Track 2>
THE EFFECTS OF FAVORITISM
ON TENDERING SYSTEMS IN
JAPANESE LOCAL
GOVERNMENTS
August 14, 2014
SATORU TANAKA
(Kobe City University of Foreign Studies)
SHUYA HAYASHI
(Nagoya University)

2. CONTENTS
1. Introduction -- Japanese Tendering
System and Its Transition
2. Favoritism in Japanese Tendering System
3. An Empirical Study on the Effects of
Favoritism on Tendering System adopted
by Local Governments
4. Conclusion
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3. 1.Introduction -- Japanese Tendering
System and Its Transition
 Japanese tendering system which is legally based
on the Japanese Accounting Law is classified into
three types of competitive tendering.
1) normal competitive tendering
(first-price sealed-bid auction)
 A contract for an offered object is awarded to
a winner of the auction who is determined by
free and fair competition among entitled
participants.
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4. 1.Introduction -- Japanese Tendering
System and Its Transition
2) scored auction
 A winner is determined by the total score
which reflects both price and non-price
attributes (quality).
3) competitive tendering by public invitation
 The government first determines participants
of an auction based on its relatively
discretionary procedure. After this process,
first-price sealed-bid auction is carried out
among the invited bidders.
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5. 1.Introduction -- Japanese Tendering
System and Its Transition
 In Japan many bid-rigging cases have been
repeatedly exposed since 1990.
(cf: Tanaka & Hayashi (2011))
 Because the causes of bid-rigging is
considered to be the lack of competitive
environment and transparency of tendering
system, procurers are forced to adopt more
competitive and transparent system.
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6. 1.Introduction -- Japanese Tendering
System and Its Transition
 This brings about a drastic change of
tendering type which public procurers mainly
adopt. Instead of the competitive tendering by
public invitation, they tend to use simple price
auction or scored auction.
 The ratio of the number of the competitive
tendering by public invitation to total number of
auction for public work: 68.86% (2007) → 45.46% (2012)
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7. 1.Introduction -- Japanese Tendering
System and Its Transition
 The nature of competition and
transparency in each tendering system
supports the recent trend of drastic
change of tendering type.
---- The procedure of determining the participants of an
auction in the competitive tendering by public invitation
heavily depends on discretion of public procurers.
---- This auction style often restricts competition among
the participants.  Table 1
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8. 1.Introduction -- Japanese Tendering
System and Its Transition
Mean std. dev. N t-value
Tendering System
price auction with public
invitation
90.59 4.34 195
simple price auction 87.64 4.52 195 13.67***
price auction with public
invitation
90.54 4.34 194
scored auction 87.54 4.40 194 13.06***
<Table 1> average number of the winning bid to reserve price in
the three tendering system
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9. １．Introduction
-- The purpose of this presentation
 In spite of the overall trend, when we focus on local
governments (prefectures) as public procurers, it is
observed that their choice of main tendering style
extremely disperses. (see Figure 1)
 Some local governments positively restraint use of the price
auction with public invitation, on the other hand other procurers
have negative attitudes to the transition towards adoption of
more competitive auction.
 In this presentation, we examine why these types of
different stance occurs by focusing on favoritism of the
local governments
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10. １．Introduction
-- The purpose of this presentation
<Figure 1> histogram about the ratio of the number of the competitive
tendering by public invitation to total number of auction in 2012
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11. 2. Favoritism in Japanese
Tendering System
 Economic reasons of three types of auctions
1) normal competitive tendering
 It is well known that simple price auction produces
desirable outcomes. (Vickley (1961), Riley & Samuelson
(1981), McAfee & McMillan (1987))
 Competitive mechanism among the bidders plays a
very important role in mitigating the difficulties caused
by the asymmetry of information between the procurer
and bidders.
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12. 2. Favoritism in Japanese
Tendering System
2) Scored auction
Under more complex situations where the quality of an
offered item is a critical factor, simple price auction may
not be adequate for the procurer.
 However, the procurer may be able to achieve the
desirable outcome by designing an adequate scoring
rule and by conducting a scored auction.
(Che (1993) and Branco (1997))
 Although the above two tendering system have
their economic reasons, price auction with public
invitation does not have clear economic reason.
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13. 2. Favoritism in Japanese
Tendering System
 Since the most significant nature of this system
is discretionary selection of participants by a
procurer before auction, we consider what
factors lead to favoritism in the Japanese
tendering system.
(cf) Typically, after a public procurer plans to
conduct an auction of an offered item, it
selects invited bidders who are permitted to
the participation of the auction from the list of
entitled (potential) bidders based on its
discretional standard.
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14. 2. Favoritism in Japanese
Tendering System
① Since a public procurer is interpreted as an
agent for the Congress, it is inevitable for a
procurer to consider interests of them when it
plans and conducts the procurement of an item.
(Laffont & Tirole (1991))
---- when the economy of a prefecture heavily depends
on construction firms located in its territory, the
request of protecting them made by its citizens is
considered to be relatively strong.
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15. 2. Favoritism in Japanese
Tendering System
---- Since a public procurer supplies goods and services
which are absolutely necessary to the daily life of its
residents, it conclude supply contracts with construction
firms which are able to supply them adequately and
promptly in case there is a contingency.
② Since in Japan fiscal year is very strictly
managed, public procurers have an incentive to
complete the projects until the end of fiscal year.
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16. 2. Favoritism in Japanese
Tendering System
 Due to this incentive, procurers often avoid the risk
that hinders the adequate completion of the project. This
risk may be revealed when the winner of the auction
goes bankrupt or engages in shoddy work as a mean of
cost reduction that is difficult to monitor by procurer.
 Since this type of risk tends to increase when price
competition among bidders is more severe, public
procurer has an incentive to avoid severe price
competition by adopting less competitive tendering style.
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17. 2. Favoritism in Japanese
Tendering System
 This discussions suggest that local
government may select less competitive
tendering system such as price competition
with public invitation
--- to protect the construction suppliers
located in its territory
--- to avoid the risk which is an obstacle
to the completion of the project.
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18. 3. An Empirical Study on the Effects of
Favoritism on Tendering System adopted by
Local Governments
 In general, owing to favoritism, when the relative
importance of construction industry in the
territory increases a prefecture’s incentive to
protect them is considered to be strong.
 In addition to this, because of strict management
of fiscal year in Japan the risk of hindering the
completion of planned projects is increased as
the competitiveness among bidders in the
prefecture is more severe.
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19. 3. An Empirical Study on the Effects of Favoritism
on Tendering System adopted by Local
Governments
<Hypothesis>
The ratio of the number of price competition with
public invitation to the number of auction is
increased
--- when the ratio of the value added in the
construction industry in the territory to gross
prefecture product is high
--- when the relative competitiveness of price
auction with public invitation is relatively low.
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20. 3. An Empirical Study on the Effects of Favoritism
on Tendering System adopted by Local
Governments
Estimated equation (using panel data):
RATIOit=α＋ΣβＸit＋μi＋εit
dependent variable (RATIOit):
the ratio of the number of price competition with
public invitation to the number of auction of
prefecture i in year t.
(source) Nikkei Construction’s survey.
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21. 3. An Empirical Study on the Effects of
Favoritism on Tendering System adopted by
Local Governments
 explanatory variables:
LOCAL: The ratio of the value added in the construction
industry in the territory to gross prefecture product.
(source) Japanese Cabinet Office, Gross Prefecture Product
COMP: Ratio of average number of the winning bid to
reserve price in price auction with public invitation to
one in simple price auction.
(source) Nikkei Construction.
SIZE: Average amount per contract.
(source) Nikkei Construction, Survey on Orders Received for Construction
(by MLIT).
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22. 3. An Empirical Study on the Effects of Favoritism
on Tendering System adopted by Local
Governments
Variables Obs. Means Std.Dev. Min. Max.
RATIO 225 0.513 0.356 0 0.999
LOCAL 235 0.657 0.015 0.038 0.128
COMP 195 1.034 0.383 0.945 1.338
SIZE 228 28.364 17.618 6.500 141.539
<Table 2> Summary Statistics of the variables
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23. 3. An Empirical Study on the Effects of Favoritism
on Tendering System adopted by Local
Governments
 Using these data, we conduct very simple panel
analysis. The results of fixed effects model
based on the above equation show that the
coefficients of both LOCALi and COMPi have
positive values in both estimation. On the other
hand, SIZE does not effect the choice of
tendering system.
↓
 It means that the increase in LOCAL and COMP
increase RATIO at 1% significance level.
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24. 3. An Empirical Study on the Effects of Favoritism
on Tendering System adopted by Local
Governments
Estimation 1 Estimation 2
const. -0.97 -1.00
(-2.98***) (-3.14***)
COMP 1.11 1.12
(3.69***) (3.70***)
LOCAL 6.10 6.09
(3.24***) (3.23**)
SIZE 0.0008
(0.28)
N 195 195
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25. 4. Conclusion
 Focusing on the discussions of favoritism in
auction theory, we clarify that the incentive to
adopt price competition with public invitation
depends on the importance of construction firms
located in the territory and the competitiveness
among bidders in the prefecture.
(cf) Notice that the favoritism by Japanese local
governments is based on not only their
concern about the conditions of local economy
but also the situation of management of
Japanese fiscal year system.
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26. 4. Conclusion
 However, favoritism may substantially facilitate
collusion among bidders and/or corruption in a
stochastic changing environment
(Lambert-Mogiliansky & Sonin (2006), Celentani & Ganuza (2002)).
↓
 It is necessary for the public procurer to design a
tendering system which reduces favoritism. This
raises a challenging problem for a society.
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27. Thank you very much for
your time and attention!
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