Abstract

Governments and corporations frequently sell assets with embedded real options to competing buyers using security bids. Examples include the sales of natural resources, real estate, patents and licenses, and start-up companies. This paper models these auctions of real options, incorporating both endogenous auction timing and post-auction option exercise. I characterize the ways common security bids distort investments and strategic auction timing affects auction initiation, security ranking, equilibrium bidding, and investment. Revenue-maximizing sellers inefficiently delay auctions, including optimal auctions which align investment incentives using a combination of down payment and royalty payment. When sellers do not restrict security design, bidding and allocation outcomes are equivalent to cash auctions. Finally, informed bidders always initiate the auctions when they could. The results are broadly consistent with empirical observations and underscore that auction timing and sellers' commitment should be jointly considered with security design in selling real options.

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