Strategic Ex-ante Contracts: Rent-Extraction and Opportunity Costs

This paper considers the possibility that a seller can contract with one uninformed buyer prior to an auction involving two potential buyers. In a more general setting than previous literature, strategic ex-ante contracts not only extract rent from entrants, but could also mitigate the seller’s ex-post rent-seeking vis-à -vis the contracted buyer, thus reducing the probability of having no trade. The seller’s optimal ex-ante contract has strategic characteristics 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 could create more social welfare than the absence of ex-ante contracts, depending on the contracted buyer’s ex-ante financial constraint and the distributions of trade surplus. This paper also shows how to implement the optimal strategic ex-ante contract by combining indirect clauses when the buyers’ valuations follow the uniform distribution. Finally, greater flexibility in policy choice and other commonly used strategic clauses are discussed