auctions with an incumbent ' s right of first refusal shelley ,
my colleague , clayton vernon , who has a background in economics , wrote a
short summary of arguments
against the rofr .
we are working on the second approach to the problem : we try to come up with
a numerical estimate of the
value of this option . the fact that an incumbent shipper has this option has
distributional consequences :
he has something of value he never paid for . having a numerical estimate of
the value of this option
could help to argue against it . the value of such an option is case specific ;
so we shall rather
produce a template you can use for valuation case by case .
vince kaminski
- - - - - - - - - - - - - - - - - - - - - - forwarded by vince j kaminski / hou / ect on 01 / 20 / 2000
08 : 34 am - - - - - - - - - - - - - - - - - - - - - - - - - - -
clayton vernon @ enron
01 / 20 / 2000 08 : 29 am
to : vince j kaminski / hou / ect @ ect
cc : stinson gibner / hou / ect @ ect , zlu / hou / ect @ ect
subject : auctions with an incumbent ' s right of first refusal
vince -
here is an essay on the issue you are discussing :
the adverse economic impact of " rights of first refusal "
an option to " first refuse " to match a competitor ' s offer is a restraint of
free trade and an impediment to efficiency in the marketplace . this economic
conclusion is unambiguous .
if an " incumbent " has the right to match an offer made by a competitor , for
an item or service of value , then few competitors will invest the time and
expense necessary to prepare and submit offers , those offers will be lower
than they would have been otherwise , and the contract will often be awarded
to an inefficient incumbent instead of a more efficient challenger .
in a traditional auction , where all bids are sealed and the item up for
auction is awarded to the highest bidder , we can safely predict the item will
be awarded to the bidder who values it the most , at a price reflecting the
full value of the item up for auction . this is the efficient result in a
market economy , because the financing of the high bid reflects resources
freely allocated to the high bidder . if the auction has open bids , we can
again safely predict the item to be awarded to the correct bidder , albeit at
a slightly lower price to the donor of the item since the bidder with the
highest valuation can simply increment by an infinitesimal amount the
second - highest valuation .
now , in a modified auction , where an incumbent bidder has the right to match
the highest bid and retain the item for himself , each competing bidder must
justify his own due diligence and bid preparation expenses against the
following , and likely , scenario : the incumbent does not spend himself for due
diligence , but instead uses these savings to help finance his matching the
top bid from a competitor .
simply put , the incumbent with a " right of first refusal " can be safely
predicted to simply match their competitor ' s bid by " rule of thumb . " but the
incumbent ' s valuation of the item up for auction can be less than the
valuation of the competitor , by the amount of the due diligence and
administrative expenses . and , the incumbent firm expropriates the expertise
of his competitors , not only in their valuations themselves , a nontrivial
financial exercise , but in any operational details required to be submitted
along with the bid .
furthermore , in an esoteric concept known as the " winner ' s curse , " a bidder
realizes that if his bid actually prevails , if the incumbent fails to match
it , he almost certainly overbid .
given this , most competitors will not even bother to bid in an auction when
an incumbent has the right of first refusal , and those that submit a bid do
not rationally invest the time , expense and expertise necessary ; they may
just " fire off " a " low - ball " bid . after all , in almost every conceivable
" state of the world " arising from the auction the competitors expect to lose
money . so , the incumbent almost always retains the contract at a
below - market price , despite the incumbent not necessarily placing the highest
value on the contract because the incumbent cannot put the contract to its
most efficient use .