'It is Never Too Late' : Optimal Penalty for Investment Delay in Italian Public Procurement Contracts

This paper provides a general framework to determine the optimal penalty fee to induce a contractor to respect the contracted delivery date in public procurement contracts (PPCs). We did this by i) developing a real option model to evaluate the investment timing flexibility that the inclusion of a penalty clause in the contract gives the contractor; ii) investigating the probability of enforcing the penalty rule which is here assumed to be negatively affected by the quality of the judicial system and by the discretionality of the court in voiding the penalty rule itself. Our model shows that the optimal penalty fee increases as the uncertainty over the contracts investment costs increases and the probability of the penalty enforcement decreases Using parameters which mimic the Italian context, we then calibrate the model to evaluate the range of penalties set by the Italian legislation on PPCs. According to our calibrations, the optimal penalty fees result highly sensitive to the quality of the judicial system and to the discretional power of courts of law: in particular, the optimal penalty for delay in PPCs should be of different level in the different Italian macro-regions and, in some cases, much higher than that set according to the present Italian law