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

Listed author(s):
  • Jean Tirole
  • Jean-Jaques Laffont

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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Paper provided by Massachusetts Institute of Technology (MIT), Department of Economics in its series Working papers with number 463.

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Date of creation: Sep 1987
Handle: RePEc:mit:worpap:463
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MASSACHUSETTS INSTITUTE OF TECHNOLOGY (MIT), DEPARTMENT OF ECONOMICS, 50 MEMORIAL DRIVE CAMBRIDGE MASSACHUSETTS 02142 USA

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Web page: http://econ-www.mit.edu/

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  1. Stein, Jeremy C, 1988. "Takeover Threats and Managerial Myopia," Journal of Political Economy, University of Chicago Press, vol. 96(1), pages 61-80, February.
  2. Hart, Oliver D & Moore, John, 1988. "Incomplete Contracts and Renegotiation," Econometrica, Econometric Society, vol. 56(4), pages 755-785, July.
  3. Grossman, Sanford J. & Hart, Oliver D., 1988. "One share-one vote and the market for corporate control," Journal of Financial Economics, Elsevier, vol. 20(1-2), pages 175-202, January.
  4. Grossman, Sanford J & Hart, Oliver D, 1986. "The Costs and Benefits of Ownership: A Theory of Vertical and Lateral Integration," Journal of Political Economy, University of Chicago Press, vol. 94(4), pages 691-719, August.
  5. 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.
  6. David Scharfstein, 1988. "The Disciplinary Role of Takeovers," Review of Economic Studies, Oxford University Press, vol. 55(2), pages 185-199.
  7. Laffont, Jean-Jacques & Tirole, Jean, 1987. "Auctioning Incentive Contracts," Journal of Political Economy, University of Chicago Press, vol. 95(5), pages 921-937, October.
  8. 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.
  9. 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.
  10. 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.
  11. Baron, David P. & Besanko, David, 1984. "Regulation and information in a continuing relationship," Information Economics and Policy, Elsevier, vol. 1(3), pages 267-302.
  12. 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.
  13. Aghion, Philippe & Bolton, Patrick, 1987. "Contracts as a Barrier to Entry," American Economic Review, American Economic Association, vol. 77(3), pages 388-401, June.
  14. Tirole, Jean, 1986. "Procurement and Renegotiation," Journal of Political Economy, University of Chicago Press, vol. 94(2), pages 235-259, April.
  15. Blair, Douglas H & Golbe, Devra L & Gerard, James M, 1989. "Unbundling the Voting Rights and Profit Claims of Common Shares," Journal of Political Economy, University of Chicago Press, vol. 97(2), pages 420-443, April.
  16. Oliver D. Hart & Jean Tirole, 1988. "Contract Renegotiation and Coasian Dynamics," Review of Economic Studies, Oxford University Press, vol. 55(4), pages 509-540.
  17. 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.
  18. 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.
  19. Laffont, Jean-Jacques & Tirole, Jean, 1988. "The Dynamics of Incentive Contracts," Econometrica, Econometric Society, vol. 56(5), pages 1153-1175, September.
  20. Riordan, Michael H & Sappington, David E M, 1987. "Awarding Monopoly Franchises," American Economic Review, American Economic Association, vol. 77(3), pages 375-387, June.
  21. 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.
  22. Victor P. Goldberg, 1976. "Regulation and Administered Contracts," Bell Journal of Economics, The RAND Corporation, vol. 7(2), pages 426-448, Autumn.
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