The design of first-price debt auction when the winning bidder can install capacity that can be expanded or contracted later

Jyh-Bang Jou

The European Journal of Finance, 2023, vol. 29, issue 5, 527-541

Abstract: This paper investigates how a seller designs the down payment rate and a bidder’s strategy in equilibrium in a first-price debt auction in which the winning bidder can exercise an investment project that can be expanded or contracted later. I find that the seller should ask a higher rate and a bidder will bid more when the bidder suffers larger losses in bankruptcy. This finding also applies to the case in which the winning bidder resells the installed capital stock at a lower price provided that he maintains the same or expands capacity on the verge of bankruptcy. As compared to the case in which a seller optimally designs the down payment rate, the seller who sets a lower one will receive lower revenue and the winning bidder, who installs a smaller capacity, will bid less and thus gain more, but his probability of bankruptcy will remain unchanged.

Date: 2023
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DOI: 10.1080/1351847X.2022.2075781

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