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Securities Auctions Under Moral Hazard: An Experimental Study

  • Author(s): Morgan, John
  • Kogan, Shimon
  • et al.
Abstract

In many settings, including venture capital financing, mergers and acquisitions, and lease competition, the structure of the contracts (debt versus equity) over which firms compete differs. Furthermore, the structure of the contract affects the future incentives of the firm to engage in value-creating activities by potentially diluting effort or investment incentives. We study, both theoretically and in the lab, the performance of open outcry debt and equity auctions in the presence of both private information and hidden effort. We show that the revenues to sellers in debt and equity auctions differ systematically depending on the returns to entrepreneurial effort. We then test these revenue rankings and other predictions of the theory using controlled laboratory experiments where we vary the returns to effort. While the bidding behavior, particularly in equity auctions, differs from the dominant strategy prediction of the theory, the predicted revenue rankings are borne out in the lab.

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