Selling real assets: The impact of idiosyncratic project risk in an auction environment

Consider a seller auctioning a real asset among n agents. Each agent contemplates a specific investment project and the asset is crucial for its activation. Project cash flows and their volatility are private information. A first-price auction is considered and the asset is granted in exchange for a payment to be paid at the investment time. Here we determine the optimal bid function and show that the auction is efficient. The asset is assigned to the project characterized by the highest volatility in the associated cash flows. Interestingly, the bid does not depend on the time at which the project is actually executed or on the changes in post-auction cash flows. We also address concerns about the distribution of the project value among the parties and show that i) the winner always holds the largest share of the ex-post project value when projects are characterized by sufficiently high cash flow volatility and ii) negative systematic risk reduces, ceteris paribus, the share accruing to the seller. Finally, we show that cash flow volatility has an ambiguous effect on losses due to the presence of information asymmetry.