The Value of Information in Auctions with Default Risk

After the close of an auction, the winning bidder may find that he is unable to carry out his bid offer. This paper seeks to determine what measures the seller should take to maximize his share of the surplus when bidders are privately informed about their risk of default. Special attention is paid to the effect of imposing a default penalty, the value of gathering information about each bidder's default risk, and the role of commitment. It is shown that the value of gathering information is negligible when the seller has commitment power and negative when the seller lacks commitment power. When the seller is informed about each bidder's risk, the seller benefits from the ability to commit. However, when the seller is uninformed, he is able to capture nearly all the surplus independent of whether or not he has commitment power.