Land Auctions with Budget Constraints

Abstract

This paper tests for the effects of financial constraints on open-bid English land auction prices and bids. It is argued that bidders’ ability to pay, taken as capital resources and/or capital budget constraints, influence bids and final auction prices. While high capital resource developers may elect to bid more than optimal to win auctions, or bidders may elect to pool resources in joint bidding, budget constraints imposed by firm-specific financial variables on the other hand are expected to restrict bids. Land auction data in Hong Kong are used to test systematically these predictions. It is found that a firm’s age, the number of winners in a joint bid, and firm status in the market are positively related to prices, all factors which may be attributed to a firm’s ability to finance the auction price. Firm size, internal funds, financing cost, debt capacity and existing capital expenditure are also shown to affect bids submitted in land auctions: firm size and internal funds are positively related to bid prices; while constrained debt capacity, financing cost and existing capital expenditure lower bids. The results are consistent with predictions that a firm’s financial constraints, and thus its effect on capital budgets, are relevant factors in predicting land auction outcomes. More generally, these findings confirm that similar financial factors that constrain corporate capital investment also influence directly acquisition of assets at auctions.