Privatization of real options

Many privatization objects have characteristics of real options in the sense that a substantial investment is required in order to make the asset productive while at the same time there is uncertainty about the future value of the asset. This paper explores several auction designs for the privatization of such assets and shows how government revenues depend on the auction designs. As a benchmark, the paper analyzes revenues from an auction with cash only. It is demonstrated that a bid that includes a bidding firm's pledged investments at the time of investment as to stimulate regional development is inferior to a cash only bid. Investments which are made compulsory by the government at the time of the actual investment or retained shareholding by the government, both announced before the auction, can augment the government's payoff. Journal of Comparative Economics 36 (3) (2008) 489-497.

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