Auctions versus Negotiations: The Role of the Payment Structure

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.