Optimal Auction Design with Contingent Payments and Costly Verification

TL;DR

This paper designs an optimal auction for income-generating assets with contingent payments and costly verification, maximizing revenue while considering auditing costs and contingent royalties.

Contribution

It introduces a novel auction mechanism that incorporates contingent payments and costly verification to optimize revenue in asset allocation.

Findings

The auction charges linear royalties with a cap, balancing upfront payments and royalties.

Higher bids lead to higher upfront payments and lower royalty caps.

The mechanism effectively maximizes revenue net of auditing costs.

Abstract

We study the design of an auction for an income-generating asset such as an intellectual property license. Each bidder has a signal about his future income from acquiring the asset. After the asset is allocated, the winner's income from the asset is realized privately. The principal can audit the winner, at a cost, and then charge a payment contingent on the winner's realized income. We solve for an auction that maximizes the principal's revenue, net of auditing costs. The winning bidder is charged linear royalties up to a cap, beyond which there is no auditing. A higher bidder pays more in cash upfront and faces a lower royalty cap.