Design of the contingent royalty rate as related to the type of investment

Jyh-Bang Jou () and Charlene Tan Lee ()
Additional contact information
Jyh-Bang Jou: National Taiwan University
Charlene Tan Lee: National Central University

Financial Innovation, 2023, vol. 9, issue 1, 1-25

Abstract: Abstract This study investigates the design of the royalty rate in a first-price auction across three types of investments: incremental and lumpy with or without an exogenously given intensity. A bidder’s investment cost comprises private information. This, together with the stochastic evolution of the price of the output generated from the auctioned project, precludes the seller from setting the exact dates of investment with the winner. However, the seller can set the royalty rate to equate the winner’s royalty payment with the winner’s information rent so that the winner acts as if to maximize the seller’s revenue. We derive two main conclusions. First, compared with the case in which investment is lumpy with an exogenously given intensity, the seller can set a lower royalty rate on incremental investment because she can collect additional royalty payments from the winner, who has the option to later expand capacity. Second, the impact of output price uncertainty on the optimal royalty rate for the three types of investments exhibits two different patterns. When investment is either incremental or lumpy with an exogenously given intensity, greater output price uncertainty reduces the royalty rate. When investment is lumpy with variable intensity, greater output uncertainty raises the royalty rate. Our results imply that auctioneers may charge differential royalty rates for different types of investments.

Keywords: Cash payment; First-price auction; Incremental investment; Lumpy investment; Mechanism design; Real options; Royalty rate; Uncertainty (search for similar items in EconPapers)
JEL-codes: D82 G11 G30 L20 (search for similar items in EconPapers)
Date: 2023
References: View references in EconPapers View complete reference list from CitEc
Citations:

Downloads: (external link)
http://link.springer.com/10.1186/s40854-023-00450-0 Abstract (text/html)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:spr:fininn:v:9:y:2023:i:1:d:10.1186_s40854-023-00450-0

Ordering information: This journal article can be ordered from
http://www.springer. ... nomics/journal/40589

DOI: 10.1186/s40854-023-00450-0

Access Statistics for this article

Financial Innovation is currently edited by J. Leon Zhao and Zongyi

More articles in Financial Innovation from Springer, Southwestern University of Finance and Economics
Bibliographic data for series maintained by Sonal Shukla () and Springer Nature Abstracting and Indexing ().