Law and Economics Approaches to Bid Rigging
New Horizons in Competition Law and Economics series
Chapter 4: Auction theory and collusion
In recent years auctions have become enormously popular and are being used in a large number of economic exchanges in both the public and private sector. They have been used in the selling of mobile phone licences, in the decentralization of electricity markets and will become the default means of allocation in the world’s largest greenhouse gas emissions trading system, the European Emissions Trading System. There are four reasons that make this allocation mechanism attractive. First, an auction is designed to lead to self-revelation of the bidder’s private values. In the presence of inherent information asymmetry in which a potential seller is unable to determine the market value of a particular object, an auction mechanism can yield higher revenues than simply quoting a price or conducting repeated negotiations with potential buyers. While this is very desirable from a theoretical point of view, it should be noted that bidders are generally reluctant to reveal their preferences because they fear that competitors could take advantage of them – thus, protection of this information is crucial for firms. Second, auctions can be designed to ensure allocative efficiency. It should be noted that efficiency here is to be understood as awarding the bidder with the highest valuation for an object with the tender.
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