Bidding into the Red: A Model of Post-Auction Bankruptcy

Abstract

This paper investigates auctions where bidders have limited liability. First, we analyze bidding behavior under different auction formats, showing that the second-price auction induces higher prices, higher bankruptcy rates, and lower utilities than the first-price auction. Second, we show that the cost of bankruptcy critically affects the seller's preference over the choice of auction. If bankruptcy is very costly, the seller prefers the first-price auction over the second-price auction. Alternatively, if the bankrupt assets are resold among the losers of the initial auction, the seller prefers the second-price auction.