Optimal profit sharing mechanisms with type-dependent outside options

Abstract

This study considers a principal using a profit sharing mechanism to select one among multiple agents with type-dependent outside options to operate a project. Under mild conditions, we fully characterize revenue-maximizing profit sharing mechanisms. Moreover, we show that if the monotonicity of the virtual valuation holds, then optimal sharing mechanisms can be implemented by the first- and second-price share auctions with an optimally chosen reserve price. We further find that the principal’s expected revenue improves as outside options diminish and break-even shares become less responsive. When outside options are linear in types, full surplus extraction is obtained.