The boards of listed companies or privatizing governments seeking to maximize profits from sales of their assets may choose from a variety of methods. In Discussion Paper No. 924, Jeremy Bulow and Research Fellow Paul Klemperer explicitly model three options: engaging in negotiations for the best possible price in a private sale to `raiders' that have expressed interest; holding an open auction among them and other bidders that then emerge; and conducting negotiations while also retaining the right to hold a subsequent auction if no sale is agreed. A skilled negotiator may secure a higher price by credibly threatening not to sell if the offers are too low or by making an offer to one buyer on the basis of information learned from the others. Proceeding directly to an auction is likely to maximize participation in bidding, since it increases both publicity and the expected surplus per bidder, but it also reduces the negotiating power of the seller, who must now simply accept the highest bid. Keeping the options open reduces the cost of negotiations that fail but it also reduces their effectiveness, since buyers know there will be another opportunity to purchase the company.

Bulow and Klemperer show that a direct auction yields the highest expected revenues provided only that it attracts at least one additional bidder; a seller should therefore never accept any `lock-up' agreement in return for not holding an open auction. This model assumes that sellers who negotiate can make commitments that would probably be impossible in practice and that bidders have no negotiating power, so it should understate the relative efficacy of auctions. It can also be used to compute the expected revenues from any chosen sales mechanism and to describe the optimal strategy for sellers that do negotiate. A further extension of the model to consider multiple unit auctions demonstrates the analogous benefit to be derived by attracting new customers rather than charging a monopoly price. Bulow and Klemperer conclude that the value of negotiating skills is smaller than that of additional competition.

Auctions vs. Negotiations
Jeremy Bulow and Paul Klemperer

Discussion Paper No. 924, March 1994 (AM)