Auctions of Real Options: Security Bids, Moral Hazard, and Strategic Timing

Abstract

This paper endogenizes auction timing and initiation in auctions of real options. Because bidders have information rent, a seller faces a virtual strike price higher than the actual exercise cost. She inefficiently delays the auction to encourage bidder participation and utilizes the irreversible nature of time to gain partial control over option exercises. The seller's private benefit at option exercise may restore efficient auction timing, but option exercises are always inefficiently late. When she lacks commitment to auction timing, bidders always initiate in equilibrium, resulting in earlier option exercise and higher welfare than auctions proscribing bidder initiation. Overall, auction timing modifies the distribution of the bidder valuations and has important impact on bidding strategies, auction design, and real outcomes.