The Role of Outside Options in Auction Design

Abstract

This paper studies revenue maximizing auctions when buyersíoutside options depend on their private information. The set-up is very general and encompasses a large number of potential applications. The main novel message of our analysis is that with type-dependent non-participation payo§s, the revenue maximizing assignment of objects can crucially depend on the outside options that buyers face. Outside options can therefore a§ect the degree of e¢ ciency of revenue maximizing auctions. We show that depending on the shape of outside options, sometimes an optimal mechanism will allocate the objects in an ex-post e¢ cient way, and other times, buyers will obtain objects more often than it is e¢ cient. Our characterization rings a bell of caution. Modeling buyersíoutside options as being independent of their private information, is with loss of generality and can lead to quite misleading intuitions. Our solution procedure can be useful also in other models where type-dependent outside options arise endogenously, because, for instance, buyers can collude or because there are competing sellers.