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Bidding securities in projects with negative externalities

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  • Hernandez-Chanto, Allan
  • Fioriti, Andres

Abstract

We analyze the allocation of an indivisible project in a security-bid auction in which: (i) the allocation of the project to one bidder causes a “negative externality” to his opponents; (ii) the winner has to pay a fixed cost to implement the project; and (iii) the winner’s implementation decision is not contractible. To study the effect of such features on the seller’s expected revenue, we focus on a second-price auction based on one of four securities: (i) cash; (ii) equity; (iii) a fixed-equity hybrid; and (iv) a fixed-cash hybrid. We show that the fixed-equity hybrid generates the highest expected revenue, whereas equity generates the lowest, even though it is the instrument with the highest linkage. Absent negative externalities, equity would generate the highest expected revenue among these four securities. The revenue ranking of the instruments is robust to the information structure and the presence of insurance deposits and entry fees.

Suggested Citation

  • Hernandez-Chanto, Allan & Fioriti, Andres, 2019. "Bidding securities in projects with negative externalities," European Economic Review, Elsevier, vol. 118(C), pages 14-36.
  • Handle: RePEc:eee:eecrev:v:118:y:2019:i:c:p:14-36
    DOI: 10.1016/j.euroecorev.2019.05.003
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    References listed on IDEAS

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    More about this item

    Keywords

    Securities; Externalities; Moral hazard; Second-price auction;
    All these keywords.

    JEL classification:

    • D44 - Microeconomics - - Market Structure, Pricing, and Design - - - Auctions
    • D62 - Microeconomics - - Welfare Economics - - - Externalities
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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