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Repeated Auctions of Incentive Contracts, Investment, and Bidding Parity with an Application to Takeovers

  • Jean-Jacques Laffont
  • Jean Tirole

This article considers a two-period model of natural monopoly and second-sourcing. The incumbent supplier invests in the first period. After observing the incumbent's first-period performance, the buyer may break out in the second period. The investment may or may not be transferable to the second source, and it may be monetary or take the form of human capital. We determine whether the incumbent should be favored at the reprocurement stage, and how the slope of his incentive scheme should evolve over time. We find that the gains from second-sourcing are not so large as one might hope. Finally, we reinterpret the second source as a raider and the breakout as a takeover. We discuss the desirability of defensive tactics and obtain a rich set of testable implications concerning the size of managerial stock options, the extent of defensive tactics, the firm's performance, and the probability of a takeover.

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Article provided by The RAND Corporation in its journal RAND Journal of Economics.

Volume (Year): 19 (1988)
Issue (Month): 4 (Winter)
Pages: 516-537

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Handle: RePEc:rje:randje:v:19:y:1988:i:winter:p:516-537
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  1. Ralph A. Walkling & Michael S. Long, 1984. "Agency Theory, Managerial Welfare, and Takeover Bid Resistance," RAND Journal of Economics, The RAND Corporation, vol. 15(1), pages 54-68, Spring.
  2. Oliver Hart & Sanford Grossman, 1985. "The Costs and Benefits of Ownership: A Theory of Vertical and Lateral Integration," Working papers 372, Massachusetts Institute of Technology (MIT), Department of Economics.
  3. Oliver Hart & John Moore, 1985. "Incomplete Contracts and Renegotiation," Working papers 367, Massachusetts Institute of Technology (MIT), Department of Economics.
  4. Joel S. Demski & David E.M. Sappington & Pablo T. Spiller, 1987. "Managing Supplier Switching," RAND Journal of Economics, The RAND Corporation, vol. 18(1), pages 77-97, Spring.
  5. Riordan, Michael H & Sappington, David E M, 1987. "Awarding Monopoly Franchises," American Economic Review, American Economic Association, vol. 77(3), pages 375-87, June.
  6. Stein, Jeremy C., 1988. "Takeover Threats and Managerial Myopia," Scholarly Articles 3708937, Harvard University Department of Economics.
  7. Klein, Benjamin & Crawford, Robert G & Alchian, Armen A, 1978. "Vertical Integration, Appropriable Rents, and the Competitive Contracting Process," Journal of Law and Economics, University of Chicago Press, vol. 21(2), pages 297-326, October.
  8. Picard, Pierre, 1987. "On the design of incentive schemes under moral hazard and adverse selection," Journal of Public Economics, Elsevier, vol. 33(3), pages 305-331, August.
  9. Oliver D. Hart & Jean Tirole, 1987. "Contract Renegotiation and Coasian Dynamics," Working papers 442, Massachusetts Institute of Technology (MIT), Department of Economics.
  10. Laffont, Jean-Jacques & Tirole, Jean, 1988. "The Dynamics of Incentive Contracts," Econometrica, Econometric Society, vol. 56(5), pages 1153-75, September.
  11. Sanford J. Grossman & Oliver D. Hart, 1987. "One Share/One Vote and the Market for Corporate Control," NBER Working Papers 2347, National Bureau of Economic Research, Inc.
  12. Jean Tirole, 1985. "Procurement and Renegotiation," Working papers 362, Massachusetts Institute of Technology (MIT), Department of Economics.
  13. Baron, David P. & Besanko, David, 1984. "Regulation and information in a continuing relationship," Information Economics and Policy, Elsevier, vol. 1(3), pages 267-302.
  14. Aghion, Philippe & Bolton, Patrick, 1987. "Contracts as a Barrier to Entry," American Economic Review, American Economic Association, vol. 77(3), pages 388-401, June.
  15. David Scharfstein, 1988. "The Disciplinary Role of Takeovers," Review of Economic Studies, Oxford University Press, vol. 55(2), pages 185-199.
  16. Victor P. Goldberg, 1976. "Regulation and Administered Contracts," Bell Journal of Economics, The RAND Corporation, vol. 7(2), pages 426-448, Autumn.
  17. Jean-Jaques Laffont & Jean Tirole, 1985. "Auctioning Incentive Contracts," Working papers 403, Massachusetts Institute of Technology (MIT), Department of Economics.
  18. Richard A. Posner, 1972. "The Appropriate Scope of Regulation in the Cable Television Industry," Bell Journal of Economics, The RAND Corporation, vol. 3(1), pages 98-129, Spring.
  19. William P. Rogerson, 1987. "On the Optimality of Menus of Linear Contracts," Discussion Papers 714, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  20. Guesnerie, Roger & Laffont, Jean-Jacques, 1984. "A complete solution to a class of principal-agent problems with an application to the control of a self-managed firm," Journal of Public Economics, Elsevier, vol. 25(3), pages 329-369, December.
  21. Oliver E. Williamson, 1976. "Franchise Bidding for Natural Monopolies -- in General and with Respect to CATV," Bell Journal of Economics, The RAND Corporation, vol. 7(1), pages 73-104, Spring.
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