essays on the theory of auctions and economic rents

ESSAYS ON THE THEORY OF AUCTIONS AND ECONOMIC RENTS DISSERTATION Presented in Partial Fulfillment of the Requirements for The Degree Doctor of Philosophy in the Graduate School of the Ohio State University By Ilgaz T. Arikan, MBA The Ohio State University 2004 Dissertation Committee: Approved by Professor Oded Shenkar, Adviser Professor Jay Barney Professor John Kagel __________________________ Professor Karen Wruck Adviser Professor Richard Makadok Business Administration Graduate Program Professor Konstantina Kiousis Copyright by Ilgaz T. Arikan 2004 ii ABSTRACT Transaction cost economics focuses on when firms should buy resources, whereas resource based view focuses on what resources firms should buy. This dissertation focuses on how firms should buy resources in factor markets to create competitive advantages. In the first chapter, I model resource acquisition by operationalizing pricing as an endogenous component of competitive strategy and compare negotiation, auction and posted price mechanisms. I identify 5 factors, which affect a firm's choice between each market mechanism. Using a hypothetical entrepreneurial firm, I model the sale of a unique resource (a patent), and argue that the question of "how a firm should buy/sell resources" is critical for our understanding of firm competitiveness. In the second chapter, I apply the model predictions of my first essay to market for firms, and study how an entrepreneurial firm should be sold. Using initial public offerings as auctions and mid-market mergers and acquisitions as negotiations, I examine the performance effects of the discrete choices entrepreneurial firms make when they sell their firm (e.g. a bundle of resources). In the third chapter, I study an application of the auction theory in practice and I investigate business-to-business online auctions and auctioneers, and their effects on firm iii competitiveness using an in depth analysis of intermediary firms and exchange rules by analyzing 4 online auctioneers. In my dissertation I focus on how firms should buy resources in factor markets to create competitive advantages. When competing in factor or product markets to acquire resources or sell goods, firms often have to make strategic decisions whether to use spot market transactions with posted prices, negotiation markets with bargaining, or auction markets with bidding. Given these three different market mechanisms, what are the firm and industry specific factors that determine different selling/buying devices to occur simultaneously in the market? By endogenizing pricing as a strategic variable, managers can choose among different market mechanisms in pursuit of rents. In this paper I model dynamic resource acquisition in equilibrium, simultaneously taking into account the characteristics of factor markets from both the sellers' and the buyers' perspectives. Auctions, negotiations and spot markets are compared given heterogeneity of expectations, bargaining power of the participants, market thickness, risk propensity and search costs. I empirically investigate my thesis and find strong support for my predictions. Based on the theoretical work by Campbell and Levin (2001) and Arikan (2002), I use predictions from the theory of auctions and negotiations to explain the optimal choice between market mechanisms in an entrepreneurial context. Two major markets exist for the sale of an entrepreneurial firm: initial public offering (IPO) versus mergers and iv acquisitions (M&A) markets. This paper argues that choosing between these two market mechanisms is not serendipitous. I argue that the discrete choice between choosing to auction off a company through an IPO or to negotiate its sale as a privately held target rests on five factors: bargaining power, resource value, market thickness, risk propensity and search costs. Using a nested logit model, I test this general discrete choice using a sample of IPOs and M&As of privately held entrepreneurial firms between 1975-1999. I find that entrepreneurial firms strongly follow the theoretical predictions developed in Arikan (2002). All else being equal, entrepreneurial firms with high bargaining power are more likely to choose negotiations (M&A) versus auctions (IPO). Firms that represent high private values (e.g. in high-tech industries) are more likely to be sold through auctions versus negotiations. As the market thickness increases, the likelihood of entrepreneurial firms being sold through M&A decreases. However, this finding is reversed for firms with higher private values. For firms with high debt ratios, the likelihood of M&A increases compared to IPOs. I find that as venture capital activity in the focal industry increases, the likelihood of M&As increases. I further investigated the use of auctions in buying and selling resources in the context of business-to-business online marketplaces. I constructed a proprietary dataset consisting of major market makers and industry players that are involved in industrial parts and machinery trade. I identified the different auction formats and rules, as well as the market structures. v ACKNOWLEDGMENTS I wish to thank my adviser Oded Shenkar, and my committee members Jay Barney, John Kagel, Karen Wruck, Konstantina Kiousis and Richard Makadok for their intellectual support, encouragement, and enthusiasm which made this thesis possible. I am grateful to Asli Arikan for her continued support and stimulating discussions on all aspects of my research interests. I benefited a lot from discussions with Juan Alcacer, Adam Brandenburger, Colin Camerer, Russ Coff, Boris Groysberg, Florian Heiss, David Hirshleifer, Anne-Marie Knott, Josh Lerner, Dan Levin, Joe Mahoney, and Bernie Yeung for their helpful comments and discussions. All the errors remain mine. I also wish to thank Reed Foster at Ravenswood Winery, Richard Langdale at NCT Ventures and various analysts at W.R. Hambrecht. They gave me great many insights from practitioners’ perspective. I gratefully acknowledge financial support from the Center for International Business Studies Research and the OSURF both at the Ohio State University. vi VITA May 5, 1971 ……………………Born – Manisa, Turkey 1994 ……………………….… BA/BS University of Marmara, Istanbul Turkey 1997 ………………………….….MBA University of North Carolina 2003-Current …………………….Instructor, Boston University PUBLICATIONS Research Publication Arikan, I. (2003) “Exit decisions of entrepreneurial firms: IPOs versus M&As” In New Venture Investment: Choices and Consequences, (Eds.) A. Ginsberg, and I. Hasan. North-Holland, Elsevier Arikan, I., and Meredith, M. (2003) “Doing Research in International Management: Use of the Internet” In 2nd Edition of Handbook of International Management Research, (Eds.) B. J. Punnett, and O. Shenkar. University of Michigan Press. FIELDS OF STUDY Major Field: Business Administration Minor Field: Economics vii TABLE OF CONTENTS Page Abstract ii Acknowledgments v Vita vi List of Tables ix List of Figures xi Chapters: 1. Introduction 1 2. Theoretical Background 4 2.1 How Do Managers Create Economic Rents? 8 2.2 Strategic Factor Markets 11 2.3 How Can Firms Create Market Imperfections? 13 2.4 Market Mechanisms For Resource Acquisition 14 2.5 Spot Markets And Posted Prices 16 2.6 Negotiation Markets And Bargaining 18 2.7 Auctions And Strategic Bidding 21 2.8 Comparing Market Mechanisms For Rent Generation 25 2.9 Discussion 32 3. Auctions Versus Negotiations 37 3.1 Market Mechanisms 39 3.2 Determinants Of Mechanism Choice 41 3.3 Ipos As Auctions 47 3.4 M&As As Negotiations 50 3.5 Empirical Analysis 55 3.5.1 Empirical Design 55 3.6 Data And Sample Description 56 3.7 Variables 59 3.7.1 Explanatory Variables 60 3.7.2 Control Variables 68 viii 3.8 Statistical Method 70 3.9 Results 76 3.10 Discussion 85 4. Economic Rent Generation In Online Auctions 93 4.1 Auctions 96 4.2 Design And Conduct Of Auction Institutions 100 4.3 Business-To-Business (B2b) Online Auctions 101 4.4 Market Makers In Online Exchanges 104 4.5 Decision Making And Bidding Capability 112 4.5 Discussion 116 List of References 128 ix LIST OF TABLES Table Page 1. Market Mechanisms and Rents (Seller) 155 2. Market Mechanisms and Rents (Buyer) 156 3 Industry Classification - 2-Digit SIC Codes 157 4. Summary of Empirical Predictions for the Nested Model for the Choice of Auctions vs. Negotiation 161 5. Number of Sellers for Mid-Market M&A Acquisitions 162 6. Average Ratio of Price Paid over Total Assets for Mid-Market M&A 163 7. Financial Information for Private Company IPOs 165 8. IPO issues by Private Firms 168 9. Manufacturing Sector by 2 Digit SIC Codes 169 10. Manufacturing Sector by Target Nation 170 11. Price Range for the IPO and M&A Deals 171 12. Descriptive Statistics 172 13. Logistic Regression of the Mechanism Choice (IPO=1, M&A=0) 173 14. Logit Model Coeff. Estimates For The Choice of Auctions (IPOs) vs. Not IPO* . 174 15. Logit Model Coeff. Estimates For the Choice of Auctions (IPOs) vs. Negotiations (M&As) 175 [...]... paradigm based on industrial organization economics, and resource-based view (RBV) of the firm, based on a combination of Penrosian economics, Austrian economics, and the evolutionary theory of the firm SCP researchers looked at product market competition and applied classical 1 industrial organization tools to explain firm performance differences and to utilize firms' strategic actions to command prices... where the resources necessary to implement a strategy are acquired (Barney, 1986) The economic foundations of RBV strongly rest on several early contributions on the dynamics of competition on product and resource markets by firms (Wernerfelt, 1984), and on the ability of firms to generate and appropriate economic rents (Rumelt, 1984) Differences between firms are in the relative efficiency by which they... allocation point, all markets clear Industrial Organization (IO) theory of the firm, relaxes the first welfare theorem assumptions, and the most important concern remains as the social planner's role to attain competitive equilibrium (Lippman and Rumelt, 1982) The nature of the goods can be either public or private, and externalities and informational asymmetries may exist among agents about products and. .. transactions are conducted without costs3 Equilibrium in perfectly competitive markets is attained when for a given price, all goods being offered are consumed, the producers maximize profits, and there is no unfulfilled demand (Arrow and Debreu, 1954) Under such conditions, the economic rents generated through auctions can only result from efficiency and productivity differences among factors of production... that there is a market for every good produced and consumed in every possible future contingency (Arrow, 1953; Debreu, 1959) In other words, there is a complete set of contingent markets, and if economic agents had full information of future events, and unlimited powers to compute benefits from all potential courses of action, and if the society could effortlessly and costlessly monitor these actions and. .. to other users, the economic rents cannot be bid away by competitors 13 Therefore, resources that are immobile, by definition are context specific, and cannot have economic rents embedded on themselves When firms acquire such resources, rents are created ex post Based on the resource heterogeneity and imperfect mobility of resources assumptions, the potential for rents arises However, prices for these... bargaining power of the parties to an exchange Heterogeneous expectations and resource immobility would also affect the choice between negotiations versus auctions 2.7 Auctions and Strategic Bidding Auctions can be broadly defined as any competition over a resource with a deadline and clear rules Changing the rules of competition determines what type of auction is in place, and firms bid their valuations to... capability (Makadok and Barney, 2001; Barney and Arikan, 2001) In addition to these three factors, managers must choose among market mechanisms for exchanges (spot market, negotiation, and auction), which in turn also affects their initial expectations The second component in auctions is institutions that set the rules to govern exchanges There are many types of auctions based on a variety of bidding rules... source of economic rents' ' (Barney and Arikan, 2001) The economic insight in creation of imperfection in factor markets follows Demsetz (1973): firms being lucky, and firms having unusual insight about the future value of a resource A general model of resources 12 and firm performance in the context of competitive advantage in RBV was later on developed by Peteraf (1993) who argued for four conditions:... the resource is valuable, rare, inimitable, and unsubstitutable, the bidding among the parties would drive the price of the resource high enough to erase economic rents In other words, if all agents have homogenous expectations about the productive capabilities of a resource, its value would be common across bidders, and competitive bidding would drive up the prices, wasting economic rents during the . based on industrial organization economics, and resource-based view (RBV) of the firm, based on a combination of Penrosian economics, Austrian economics, and the evolutionary theory of the firm ESSAYS ON THE THEORY OF AUCTIONS AND ECONOMIC RENTS DISSERTATION Presented in Partial Fulfillment of the Requirements for The Degree Doctor of Philosophy in the Graduate. bundle of resources). In the third chapter, I study an application of the auction theory in practice and I investigate business-to-business online auctions and auctioneers, and their effects on