The Effect of Leverage on Bidding Behavior: Theory and Evidence from the FCC Auctions

This paper investigates how firm bidding behavior in various auctions is affected by capital structure. A theoretical model is developed where the first price sealed bid and second price sealed bid auctions are examined in situations where the firms are competing for an asset with either a common value or a private value. Findings include that in the presence of exogenous and symmetric debt, the revenue equivalence theorem no longer holds, and hence, there may be an optimal auction or set of auctions that yield the maximum expected revenue to the seller. In addition, as debt level increase, firms will tend to decrease their bids. The lower bid function gives the competition incentives to decrease their bid as well. Thus, we would expect a firm's bid to be a function of both its own debt level and the debt level of the competition, and an increase in either should result in a decrease in the firm's bid. The empirical part of the paper applies these ideas to recent FCC auctions. The evidence is consistent with the theoretical model. Debt levels of the bidding firm and the competition are found to be determinants of the highest bid a firm is willing to submit in the auction, and higher debt levels (by the firm or its competition) lead to lower bids.