Real options with ex-post division of the surplus

This paper examines a real option model where two vertically related firms are involved in a specific investment project that is subject to an uncertain payoff. While ex-post bargaining between a seller and a buyer leads to underinvestment by the seller in a standard model where timing of the seller’s investment is exogenous, we show that this need not be the case when the seller’s timing of investment is endogenous. However, bargaining with a buyer leads to excessive waiting. More severe holdup and higher uncertainty will lead to vertical integration of activities to avoid timing inefficiencies.     

Strategic ex ante contracts: rent extraction and opportunity costs

This article cosiders the possibility that a seller can contract with one uninformed buyer prior to an auction involving two potential buyers. The seller's optimal strategic ex ante contract more accurately reflects joint opportunity costs of the seller and the contracted buyer, and therefore extracts more rent from the entrant. Moreover, this ex ante contract mitigates the seller's ex post rent seeking vis‐à‐vis the contracted buyer. Accordingly, it may create more social welfare than the absence of ex ante contracts, depending upon the contracted buyer's financial constraint and the distributions of trade surplus. Implementation of the optimal strategic ex ante contract and policy implications are discussed.     

Payoff uncertainty,bargaining power,and the strategic sequencing of bilateral negotiations

This article investigates the sequencing choice of a buyer who negotiates with the sellers of two complementary objects with uncertain payoffs. The possibility of inefficient trade may generate strict sequencing preference. The buyer begins with the weaker seller if the sellers have diverse bargaining powers and with the stronger one if both sellers are strong bargainers. This sequencing is likely to increase the social surplus. Moreover, the buyer may find it optimal to raise her own acquisition cost by committing to a minimum purchase price or outsourcing. The first‐ and second‐mover advantages for the sellers are also identified.     

An offer you can't refuse: early contracting with endogenous threat

A seller has private information on the future gains from trade with a buyer, but the buyer has the option to invest to produce the good internally. Both the buyer and the seller can efficiently trade ex post under complete information. Despite the lack of information, the buyer sometimes gains by making an early contract offer to the seller. The early contract divides the different types of sellers according to their information, which renders the threat of producing the good in‐house credible and enables the buyer to extract a larger share of the gains from trade. Several extensions are investigated.     

Specification and negotiation in incomplete contracts

We investigate contractors' bargaining power and holdup on buyers in procurement auctions of incomplete contracts held by California Department of Transportation. Using a model where contractors bid competitively in response to a buyer's choice of initial contract design, we infer the contractors' costs and bargaining power from the bids and transfers negotiated after the auction. We find that the contract winners have substantial bargaining power in post‐auction negotiation. The average holdup on the buyer is about 20% of project costs. Counterfactual cost‐plus contracts would reduce the buyer's surplus in 72% of the projects, with an average reduction over $382,000.     

Bargaining Strength and Property Class in Office Markets

This paper examines the influence of bargaining power and property class on the prices of heterogeneous goods. Specifically, it explores the impact of buyer and seller characteristics on the transaction prices of office properties. The empirical model is based on the work of Harding, Rosenthal, and Sirmans (2003), which developed a method to distinguish between the impact of buyer and seller attributes on bargaining power and the choice of otherwise unidentified price effects (i.e., property class) in the context of hedonic price models. The data set contains information on transaction prices of office properties in Cook, DuPage, and Lake Counties, Illinois from 1995 to 1997. The results reveal systematic differences in bargaining power and property class for certain groups of buyers and sellers contained within the sample.     

Investing in a relationship

A principal can make an investment anticipating a repeated relationship with an agent, but the agent may appropriate the returns through ex post bargaining. I study how this holdup problem and efficiency depend on the contracting environment. When investment returns are observable, informal contracts ex post can be more efficient than formal contracts, as they induce higher investment ex ante: the principal invests not only to generate direct returns, but also to improve relational incentives. Unobservability of returns increases the principal's ability to appropriate the returns but reduces her ability to improve incentives. The optimal information structure depends on bargaining power.     

An optimal auction with identity‐dependent externalities

We analyze the problem of a seller of multiple identical units of a good who faces a set of buyers with unit demands, private information, and identity‐dependent externalities. We derive the seller's optimal mechanism and characterize its main properties. We show that the probability that a buyer obtains a unit is an increasing function of the externalities he generates and enjoys. Also, the seller's allocation of the units of the good need not be ex post efficient. As an illustration, we apply the model to the problem faced by a developer of a shopping mall who wants to allocate and price its retail space among anchor and non‐anchor stores. We show that a commonly used sequential mechanism is not optimal unless externalities are large enough.     

Optimal disclosure decisions when there are penalties for nondisclosure

We study a seller of an asset who is liable for damages if the seller fails to disclose to buyers an estimate of the asset's value he knew prior to the sale. Our results include as either the “damages multiplier” that determines the size of the damages the seller must pay buyers increases, or as the probability the seller is caught withholding his estimate from buyers increases, the seller discloses his estimate less often, and as the precision of the seller's estimate increases, he sells a larger fraction of the asset.     

Corporate Restructuring and Bondholder Wealth

This paper provides an overview of existing research on how corporate restructuring affects bondholder wealth. Restructuring is defined as any transaction which affects the firm's riskiness by changing its underlying capital structure. Thus, it reaches well beyond asset restructuring and includes transactions such as leveraged buyouts, security issues and exchanges, and the issuance of stock options. We identify significant gaps in the literature, emphasize the potential differences in bond performance between market‐ and stakeholder‐oriented corporate governance systems, and provide valuable insights into methodological advances. We find that many issues remain as the empirical evidence is often inconclusive and focuses almost exclusively on the US. Research on other countries remains constrained by the lesser development of their bond markets, but is equally imperative because the position and bargaining power of creditors vis‐à‐vis the firm differ substantially across countries and governance regimes.     

Information and the hold‐up problem

We examine situations in which a party must make a sunk investment prior to contracting with a second party to purchase an essential complementary input. We study how the resulting hold‐up problem is affected by the seller's information about the investing party's likely returns from its investment. Our principal focus is on the effects of the investment's being observable by the noninvesting party. We establish conditions under which the seller's ability to observe the buyer's investment harms the seller, benefits the buyer, and reduces equilibrium investment and total surplus. We also note conditions under which investment and welfare rise when investment is observable.     

Smooth investment

In the classical portfolio optimization problem considered by Merton, the resulting constant proportion investment plan requires a diffusive trading strategy. This means that, within any arbitrarily small time interval, the investor must impractically both buy and sell stocks. We study the problems of a mean-square and a power utility investor for whom the trading strategy is constrained to be smooth, i.e. nondiffusive. This means that over sufficiently small time intervals, the investor is either a seller or a buyer of stocks. The mathematical framework is built around quadratic objectives such that trading activity is punished quadratically. Mean-square utility is quadratic, and power utility is covered by quadratic punishment of distance to Merton’s power utility portfolio. We present semi-explicit solutions and, in a series of numerical illustrations, show the impact of trading constraints on the portfolio decision over the investment horizon.     

Methods of Payment in Asset Sales: Contracting with Equity versus Cash

We analyze intercorporate asset sales where equity is the means of payment, and compare the results to cash asset sales. Equity deals are value‐enhancing for both buyers, 10%, and sellers, 3%, while cash sales generate seller returns of 1.9% and buyer returns that are not significant. Combined wealth gains are large for equity deals, but modest for cash deals. Equity‐based asset sales are not a precursor to consolidations between buyers and sellers, and do not affect buyer openness to the takeover market. We conclude that the use of buyer equity conveys favorable information about the value of assets and buyers.     

Do buyer‐size discounts depend on the curvature of the surplus function? Experimental tests of bargaining models

A number of recent theoretical papers have shown that, for buyer‐size discounts to emerge in a bargaining model, the total surplus function over which parties bargain must have certain nonlinearities. We test the theory in an experimental setting in which a seller bargains with a number of buyers of different sizes. Nonlinearities in the surplus function are generated by varying the shape of the seller's cost function. Consistent with the theory, we find that quantity discounts emerge only in the case of increasing marginal cost, corresponding to a concave surplus function. We provide additional structural estimates to help identify the source of remaining discrepancies between experimental behavior and theoretical predictions (whether due to preferences for fairness or other factors such as computation errors).     

Buyer power and mutual dependency in a model of negotiations

We study bilateral bargaining between several buyers and sellers in a framework that allows both sides, in case of a bilateral disagreement, flexibility to adjust trade with each of their other trading partners and receive the gross benefit generated by each adjustment. A larger buyer pays a higher per‐unit price when buyers' bargaining power in bilateral negotiations is sufficiently low, and a lower price otherwise. An analogous result holds for sellers. These predictions, and the implications of different technologies, are explained by the fact that size is a source of mutual dependency and not an unequivocal source of power.     

How limiting deceptive practices harms consumers

There are two competing sellers of an experience good, one offers high quality, one low. The low‐quality seller can engage in deceptive advertising, potentially fooling a buyer into thinking the product is better than it is. Although deceptive advertising might seem to harm the buyer, we show that he could be better off when the low‐quality seller can engage in deceptive advertising than not. We characterize the optimal deterrence rule that a regulatory agency seeking to punish deceptive practices should adopt. We show that greater protection against deceptive practices does not necessarily improve the buyer welfare.     

Transaction duration and asymmetric price impact of trades—Evidence from Australia

This paper investigates the asymmetric price impact of buyer and seller initiated trades and the informational role of the trade duration. Using trade data from the Australian Stock Exchange (ASX), our results indicate that buyer initiated trades increase the ask price more than the bid price, and seller initiated trades decrease the bid price more than the ask price. The transaction duration is modeled in a Box-Cox ACD framework. The unexpected portion of the duration is found to play a more significant role in causing price impact in both purchases and sales than the expected duration. A trade shortly after the previous trade results in higher price impact than one after a long period. We found evidence that increased trading activity is associated with larger price impact, therefore implying a higher degree of information-based trading.     

Investment,agency conflicts,debt maturity,and loan guarantees by negotiation

We consider an irreversible investment, of which the sunk cost is financed by a finite-term debt after entering into an option-for-guarantee swap (OGS) with negotiation. The OGS is a three-party agreement among a lender (bank), an insurer, and a borrower (entrepreneur), where the bank lends at a given interest rate to the entrepreneur and if the borrower defaults on debt, the insurer must pay all the principal and remaining interests to the lender instead of the borrower. In return for the guarantee, the borrower must allocate a perpetual American call option to purchase a fraction (guarantee cost) of his equity at a given strike price. We find that the investment threshold decreases but the exercise threshold of the insurer’s option increases with the borrower’s bargaining power. Both the investment and exercise threshold increase with debt maturity, but there is a U-shaped relation between the guarantee cost and debt maturity. The borrower postpones investment once the funding gap or project risk increases. The swap may overcome the inefficiencies from asset substitution and debt overhang, strongly depending on the debt maturity and borrower’s bargaining power.     

Optimal information transmission in a holdup problem

This article examines the optimal contract in a bilateral trade model with unobservable relationship‐specific investment and renegotiation. In such a setting, a contract plays an additional role that it does not have in the standard holdup model, namely that of transmitting information between the parties. The article shows that a partial‐disclosure contract may be optimal and describes the optimal contract. If the investment is cooperative and the information between the trading parties is asymmetric, the optimal contract generally cannot result in the first best, but dispensing with either of these assumptions makes the first‐best achievable.