Auctions versus Negotiations: The Role of the Payment Structure

ABSTRACT We investigate a seller's strategic choice between optimally structured negotiations with fewer bidders and an auction with more competing bidders when payments can have a contingent component, as is common in mergers and acquisitions (M&A), patent licensing, and employee compensation. The key factor favoring negotiations is that it allows the seller to set her preferred payment structure—that is, the revenue‐maximizing mix of cash and contingent pay; reserve prices are of secondary importance. Negotiations are more likely to dominate if synergies increase in bidders' productivity types (as with acquirer‐target complementarities in M&A). Higher dispersion and magnitude of bidders' private valuations also favor negotiations.