Rational Participation Revolutionizes Auction Theory

Abstract

Potential bidders respond to a seller's choice of auction mechanism for a common-value or affiliated-values asset by endogenous decisions whether to incur a participation cost (and observe a private signal), or forego competing. Privately informed participants decide whether to incur a bid-preparation cost and pay an entry fee, or cease competing. Auction rules and information flows are quite general; participation decisions may be simultaneous or sequential. The resulting revenue identity for any auction mechanism implies that optimal auctions are allocatively efficient; a nontrivial reserve price is revenue-inferior for any common-value auction. Optimal auctions are otherwise contentless: any auction that sells without reserve becomes optimal by adjusting any one of the continuous, spanning parameters, e.g., the entry fee. Seller's surplus-extracting tools are now substitutes, not complements. Many econometric studies of auction markets are seen to be flawed in their identification of the number of bidders.