Bloomfield & Luft (2006)
3 important questions on Bloomfield & Luft (2006)
What is the winner's curse?
This is when sellers fail to recognize that the bidder with the lowest cost estimate is likely to have the largest cost underestimate.
What is/are the (normative) benchmark(s) against which the judgment(s) or decision(s) are compared?
In this case, the normative benchmark is the equilibrium strategy. The equilibrium strategy is that all equilibrium bids include a large amount of padding to avoid winner's curse. Those who believe they have a cost advantage should pad less, while those who believe they have a cost disadvantage should pad more. Thus, sellers should not only bid lower when they receive lower cost-estimates, but they should include enough padding to the cost estimate to allow for the negative error. In this way they can make a satisfactory expected profit when they win the bid.
What is cost padding?
Padded costs, the difference between real and observed costs, are a post-contractual hidden action, chosen by the firm to increase its cost reimbursement.
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