“Strategic Ex-ante Contracts: Rent Extraction and Opportunity Costs” by Xinyu HUA
Hong Kong University of Science and Technology
This paper considers the possibility that a seller can contract with one uninformed buyer prior to an auction involving two potential buyers. Strategic ex-ante contracts not only extract rent from entrants, but also can mitigate the seller’s ex-post rent-seeking vis-à-vis the contracted buyer. The seller’s optimal ex-ante contract more accurately reflects joint opportunity costs of the seller and the contracted buyer. This strategic characteristic is similar to the right of first refusal, a commonly used clause. Moreover, this optimal ex-ante contract specifies a lower trade barrier for the contracted buyer. Accordingly, it can create more social welfare than the absence of ex-ante contracts, depending upon the contracted buyer’s financial constraint and the distributions of trade surplus. This paper illustrates how to implement the optimal strategic ex-ante contract by combining indirect clauses. Finally, robustness and policy implications are discussed.