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Debt- Versus Equity-Financing in Auction Designs

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  • Zheng, Charles Zhoucheng

Abstract

A social planner wishes to launch a project but the contenders capable of running the project are cash-constrained and may default. To signal their capabilities, the contenders may finance their bids through debt or equity, depending on the mechanism chosen by the social planner. When moral hazard is absent, it is established as theorems that the ex post efficient social choice function cannot be achieved by any mechanism using only debt financing and can be achieved by a mechanism using equity financing. When moral hazard is present, however, it is illustrated heuristically that equity share discourages effort and exacerbates default more than risky debt does.

Suggested Citation

  • Zheng, Charles Zhoucheng, 2010. "Debt- Versus Equity-Financing in Auction Designs," Staff General Research Papers Archive 31517, Iowa State University, Department of Economics.
  • Handle: RePEc:isu:genres:31517
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    File URL: http://www2.econ.iastate.edu/papers/p11517-2010-05-18.pdf
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    References listed on IDEAS

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    1. Yeon-Koo Che & Ian Gale, 1998. "Standard Auctions with Financially Constrained Bidders," Review of Economic Studies, Oxford University Press, vol. 65(1), pages 1-21.
    2. Maskin, Eric S., 2000. "Auctions, development, and privatization: Efficient auctions with liquidity-constrained buyers," European Economic Review, Elsevier, vol. 44(4-6), pages 667-681, May.
    3. Waehrer Keith, 1995. "A Model of Auction Contracts with Liquidated Damages," Journal of Economic Theory, Elsevier, vol. 67(2), pages 531-555, December.
    4. Simon Board, 2007. "Bidding into the Red: A Model of Post-Auction Bankruptcy," Journal of Finance, American Finance Association, vol. 62(6), pages 2695-2723, December.
    5. Matthew Rhodes-Kropf & S. Viswanathan, 2005. "Financing Auction Bids," RAND Journal of Economics, The RAND Corporation, vol. 36(4), pages 789-815, Winter.
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    Cited by:

    1. Burkett, Justin, 2016. "Optimally constraining a bidder using a simple budget," Theoretical Economics, Econometric Society, vol. 11(1), January.

    More about this item

    Keywords

    auction; finance; debt; equity; default; financial constraint; budget constraint;

    JEL classification:

    • D44 - Microeconomics - - Market Structure, Pricing, and Design - - - Auctions
    • D92 - Microeconomics - - Micro-Based Behavioral Economics - - - Intertemporal Firm Choice, Investment, Capacity, and Financing

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