Security bid auctions for agency contracts

Abstract

A principal uses security bid auctions to award an incentive contract to one among several agents in the presence of hidden action and hidden information. Securities range from cash to equity and call options. “Steeper” securities are better surplus extractors, yet reduce effort incentives. In view of this trade-off, a hybrid share auction that includes a cash reward to the winner, a minimum share, and an option to call a fixed wage contract, tends to outperform all other auctions, although it is not an optimal mechanism. However, by adding output targets a hybrid share auction can (arbitrary closely) implement the optimal mechanism.