Debt- Versus Equity-Financing in Auction Designs

A social planner wishes to launch a project but the contenders capable of runningthe project are cash-constrained and may default. To signal their capabilities, thecontenders may finance their bids through debt or equity, depending on the mechanismchosen by the social planner. When moral hazard is absent, it is established as theoremsthat the ex post efficient social choice function cannot be achieved by any mechanismusing only debt financing and can be achieved by a mechanism using equity financing.When moral hazard is present, however, it is illustrated heuristically that equity sharediscourages effort and exacerbates default more than risky debt does.[...]