Preemptive Bidding Research Articles

Entry Deterrence and Free Riding in License Auctions: Incumbent Heterogeneity and Monotonicity

Abstract We examine free riding for entry deterrence in license auctions with heterogeneous incumbents. We establish the monotonicity of randomized preemptive bidding equilibria: an incumbent with a higher entry-loss rate has greater free-riding incentive, choosing a lower deterring probability. We then identify conditions for the existence of a series of fully or partially participating equilibria such that two or more incumbents with bounded heterogeneity in their entry-loss rates participate in randomized preemptive bidding. As an application, we examine a simple case of a bipartite group of participating incumbents consisting of one “leader” and many “followers”. We show that the policy of limiting the leader’s participation (set-asides for entrants, limiting participation of incumbents with excessive market shares, etc.) may or may not increase entry probability.

Entry Deterrence and Free Riding in License Auctions: Incumbent Heterogeneity and Monotonicity

We examine free riding for entry deterrence in license auctions with heterogeneous incumbents. We establish the monotonicity of randomized preemptive bidding equilibria: an incumbent with a higher entry-loss rate has greater free-riding incentive, choosing a lower deterring probability. We then identify conditions for the existence of a series of fully or partially participating equilibria such that two or more incumbents with bounded heterogeneity in their entry-loss rates participate in randomized preemptive bidding. As an application, we examine a simple case of a bipartite group of participating incumbents consisting of one “leader” and many “followers”. We show that the policy of limiting the leader’s participation (set-asides for entrants, limiting participation of incumbents with excessive market shares, etc.) may or may not increase entry probability.

Preemptive bidding in common value takeover auctions: Social surplus and the target’s revenue

This paper develops a model of preemptive jump bidding in common value takeover auctions. It shows that, in a case of common values, jump bidding increases the social surplus and, under certain conditions, can lead to a higher expected target’s revenue. It also demonstrates that an increase in investigation costs may improve social efficiency even if it leads to larger direct social costs. Based on the results, the paper provides several implications related to legal fees and the length of the takeover contest.

Surplus dissipating equilibria in the dollar auction

We analyze symmetric subgame perfect equilibria of the dollar auction in its original format, without the modifications that the literature adopts to rule out overbidding in the game. The game has a continuum of subgame perfect equilibria, generating expected revenues that range from zero to the full value of the contested prize. Such multiplicity of equilibria suggests that the overbidding pattern often observed in experiments of this game might be symptoms of coordination failure among bidders, consistent with the rational choice paradigm with no need for behavioral or psychological explanations. The analysis is shown robust to extensions considering: (i) alternative tie-breaking rule that allows for multiple frontrunners, and (ii) preemptive bidding by the frontrunner.

Early Entry to Verify Quality Stimulates Breakthrough Innovations

Most OECD-countries provide financial subsidy programs to stimulate the entry and growth of small entrepreneurial firms. However, the best strategy for innovative entrepreneurs might be to make an early entry to signal innovation quality and overcome asymmetry problems. Thereby, entrepreneurs can induce a preemptive bidding competition among incumbents and receive a higher acquisition price. This stimulates entrepreneurs to develop breakthrough innovations that will raise welfare.

Verifying High Quality: Entry for Sale

When and how do entrepreneurs sell their inventions? To address this issue, we develop an endogenous entry-sale asymmetric information oligopoly model. We show that low quality inventions are sold directly or used for own entry. Inventors who sell post-entry use entry to credibly reveal information on quality. Incumbents are then willing to pay high prices for high-quality inventions to preempt rivals from obtaining them. Using Swedish data on patents granted to small firms and individuals, we find evidence that high-quality inventions are sold under preemptive bidding competition, post entry.

Preemptive Bidding in Common Value Takeover Auctions: Social Surplus and Seller's Revenue

This paper develops a model of preemptive jump bidding in common value takeover auctions. It shows that in a case of common values jump bidding increases the social surplus, and, under certain conditions, can lead to higher expected seller’s revenue. It also demonstrates that an increase in investigation costs may improve social efficiency even if they lead to direct social costs. Based on its results, the paper provides several implications related to legal fees and the length of takeover auctions.

Preemptive bidding and Pareto efficiency in takeover auctions

This paper extends the Fishman (1988) model of preemptive jump bidding in private value takeover auction to auctions with common and affiliated values. We show that in the presence of a common value component, jump bidding equilibrium results in higher social surplus. Furthermore, we show that, under certain conditions, allowing for preemptive jump bidding in common value auctions results in ex-ante Pareto improvement.

Preemptive Bidding and Pareto Efficiency in Takeover Auctions

This paper extends the Fishman (1988) model of preemptive jump bidding in private value takeover auction to auctions with common and affiliated values. We show that in the presence of a common value component, jump bidding equilibrium results in higher social surplus. Furthermore, we show that, under certain conditions, allowing for preemptive jump bidding in common value auctions results in ex-ante Pareto improvement.

Creative destruction and productive preemptive acquisitions

We develop a model of entrepreneurial innovation for entry and sale into oligopolies suitable for welfare analysis. We show that the expected consumer welfare can be higher under commercialization by sale than under commercialization by entry despite increased market power in the product market. The reason is that when the quality of the invention is sufficiently high, preemptive bidding competition among incumbents drives the acquisition price above the entry value. Entrepreneurs who sell their inventions will then have a stronger incentive to develop high-quality inventions than entrepreneurs who aim at entering the product market. Incumbents are hurt by this creative destruction process ignited by the entrepreneurs and thus have an incentive to undertake research to block entrepreneurs' research activities. We show that incumbents' own research effort can reduce, but not eliminate, the entrepreneurs' incentives to innovate for entry or sale.

Bidder contests in international mergers and acquisitions: The impact of toeholds, preemptive bidding, and termination fees

For international mergers and acquisitions we analyze the effectiveness of different bidder strategies, first in preventing bidder competition, and second in increasing the likelihood of success. We provide robust empirical evidence of the effectiveness of toeholds and termination fees in reducing the likelihood of competition and, if a contest occurs, increasing the probability of success, especially after controlling for bidder asymmetries. The effects of termination fees vary over time and legal origin. Overall, there is hardly any evidence that high initial offers can prevent contests. However, competition is preempted in civil law countries with a high initial premium. A higher percentage of cash payment also increases the probability of success in bidder contest. Moreover, latent competition is generally not sufficient to curb the influence of observable bidder competition on target and bidder wealth. Finally, serial acquirers are more likely to prevent bidder contests and experienced and reputably advised bidders are more successful in deal completion. Overall, we offer novel evidence for the success of different bidding strategies in international mergers and acquisitions.

Preemptive bidding, target resistance, and takeover premiums

We evaluate empirically two sources of large takeover premiums: preemptive bidding and target resistance. We develop an auction model that features costly sequential entry of bidders in takeover contests and encompasses both explanations. We estimate the model parameters by simulated method of moments for a sample of US takeovers. Our estimates imply that target resistance explains the entire magnitude of the premium in 74% of successful single-bidder contests. Simulation experiments show that initial bidders have, on average, a higher valuation for the target than rival bidders, so that a relatively low initial bid is sufficient to deter a rival from entry.

Should Sellers Prefer Auctions? A Laboratory Comparison of Auctions and Sequential Mechanisms

When bidders incur a cost to learn their valuations, bidder entry can impact auction performance. Two common selling mechanisms in this environment are an English auction and a sequential bidding process. Theoretically, sellers should prefer the auction, because it generates higher expected revenues, whereas bidders should prefer the sequential mechanism, because it generates higher expected bidder profits. We compare the two mechanisms in a controlled laboratory environment, varying the entry cost, and find that, contrary to the theoretical predictions, average seller revenues tend to be higher under the sequential mechanism, whereas average bidder profits are approximately the same. We identify three systematic behavioral deviations from the theoretical model: (1) in the auction, bidders do not enter 100% of the time; (2) in the sequential mechanism, bidders do not set preemptive bids according to the predicted threshold strategy; and (3) subsequent bidders tend to overenter in response to preemptive bids by first bidders. We develop a model of noisy bidder-entry costs that is consistent with these behaviors, and we show that our model organizes the experimental data well. Data, as supplemental material, are available at http://dx.doi.org/10.1287/mnsc.2013.1800. This paper was accepted by Teck Ho, behavioral economics.

Can preemptive bidding in takeover auctions be socially optimal? Yes it can

This paper analyzes a model of preemptive jump bidding in private value takeover auctions with entry costs. It shows that when the second bidder owns a fraction of the target firm preemptive jump bidding leads to a higher social surplus, improves the expected profit of both bidders and reduces the expected final price. Such a toehold also leads to higher jump bids. The model implies that preemptive bidding hurts the minority shareholders but benefits the large shareholder of the target firm.

Preemptive bidding in takeover auctions with externality

This paper analyzes the preemptive jump bidding equilibrium in takeover auctions when the acquisition of the target firm by one of the bidders may affect the profit of the other bidder. It shows that such externality has no effect on the preemption rate but affects the size of the jump bid required to preempt competition. Namely, the required jump bid is lower in the presence of positive externality and it is higher when the externality is negative. Preemptive bidding does not affect the expected profit of the second bidder, increases the expected profit of the first bidder and leads to lower expected profit of the seller. The effect of the jump bidding on the seller's profit and the social surplus negatively depends on the externality.

Preemptive Bidding in Takeover Auctions: An Experimental Study

This paper presents the results of an experimental study on jump bidding in takeover auctions with entry costs. It provides support for signaling hypothesis behind jump bidding and analyzes how the size of the entry costs affects the bidders' behavior and their expected profits. It also shows that jump bidding allows the reallocation of the surplus from the seller to the first bidder but has little effect on the social surplus and the profits of the second bidder. Copyright © 2013 John Wiley & Sons, Ltd.

Preemptive bidding in takeover auctions with affiliated values

► Preemptive bidding reallocate profit from the seller to the first bidder and does not affect the social surplus. ► Higher correlation of bidders’ values leads to higher preemption rate but has ambiguous effect on the size of the preemptive bid. ► In affiliated value auctions jump bidding may results in expropriation of the entire seller's profit by the first bidder. ► Value affiliation positively affects profit expropriation but has ambiguous effect on the seller's expected profit. ► A significant increase in the value affiliation reduces the seller's expected profit. This paper extends Fishman's (1988) model of preemptive bidding in takeover auctions to auctions with affiliated values. It shows that preemptive bidding transfers wealth from the seller to the first bidder without affecting the profit of the second bidder and social welfare. It also shows that higher correlation between bidders’ values leads to higher preemption rates but has an ambiguous effect on the size of the opening bid. Finally, it shows that in auctions with affiliated values, even infinitesimal entry costs may lead to a preemptive jump bidding that allows the reallocation of the entire surplus from the seller to the first bidder.

Demand reduction and preemptive bidding in multi-unit license auctions

Multi-unit ascending auctions allow for equilibria in which bidders strategically reduce their demand and split the market at low prices. At the same time, they allow for preemptive bidding by incumbent bidders in a coordinated attempt to exclude entrants from the market. We consider an environment where both demand reduction and preemptive bidding are supported as equilibrium phenomena of the ascending auction. In a series of experiments, we compare its performance to that of the discriminatory auction. Strategic demand reduction is quite prevalent in the ascending auction even when entry imposes a (large) negative externality on incumbents. As a result, the ascending auction performs worse than the discriminatory auction both in terms of revenue and efficiency, while entrants’ chances are similar across the two formats.

Toeholds and signalling in takeover auctions

This paper presents a model of preemptive bidding in takeover auctions with toeholds. It shows that when the first bidder owns a fraction of the target firm he is more likely to deter competition and a smaller jump bid is required to do so. It also shows that in the presence of the toehold, the signalling equilibrium reduces the social surplus while it has no effect on the social surplus in the absence of the toehold.

A Laboratory Comparison of Auctions and Sequential Mechanisms

When bidders incur a cost to learn their valuations, bidder entry can impact auction performance. Two common selling mechanisms in this environment are an English auction, and a sequential bidding process. Bulow and Klemperer (2009) show, theoretically, that sellers should prefer the auction, because it generates higher expected revenues, while bidders should prefer the sequential mechanism, because it generates higher expected bidder profits. We compare the two mechanisms in a controlled laboratory environment, varying the entry cost, and find that, contrary to the theoretical predictions, average seller revenues tend to be higher under the sequential mechanism, while average bidder profits are approximately the same. We identify three systematic behavioral deviations from the theoretical model: (1) in the auction, bidders do not enter 100% of the time, (2) in the sequential mechanism, bidders do not set pre-emptive bids according to the predicted threshold strategy, and (3) subsequent bidders tend to over-enter in response to pre-emptive bids by first bidders. We develop a model of noisy bidder entry costs that is consistent with these behaviors, and show that our model organizes the experimental data well.