DP5118 Optimal Privatization Using Qualifying Auctions

Author(s): Jan Boone, Jacob K. Goeree
Publication Date: July 2005
Keyword(s): information advantage, privatization, qualifying auction, winner's curse
JEL(s): D44, D82, L33
Programme Areas: Industrial Organization
Link to this Page: www.cepr.org/active/publications/discussion_papers/dp.php?dpno=5118

This paper explores the use of auctions for privatizing public assets. In our model, a single ‘insider’ bidder (e.g. incumbent management of a government-owned firm) possesses information about the asset’s risky value. In addition, bidders are privately informed about their costs of exploiting the asset. Due to the insider’s presence, uninformed bidders face a strong winner’s curse in standard auctions with devastating consequences for revenues. We show that the optimal mechanism discriminates against the informationally advantaged bidder to ensure truthful information revelation. The optimal mechanism can be implemented via a simple two-stage ‘qualifying auction.’ In the first stage of the qualifying auction, non-binding bids are submitted to determine who enters the second stage, which consists of a standard second-price auction augmented with a reserve price.