Favoritism in Asymmetric Procurement Auctions

I examine the economic costs and benefits of granting a right of first refusal to one of two bidders in a procurement auction. This right permits the favored bidder to win a contract by matching the bid of the competing bidder. Such a right, is often observed in business interactions, especially procurement. It is commonly thought that the right of first refusal lowers the payoff to the auctioneer; however, I show conditions under which the auctioneer benefits. I also explore the effect of allowing the auctioneer to set a reserve price and find that the benefits of a right of first refusal still hold. An endogenous reserve price diminishes the cost-reducing effect of a right of first refusal. Both the reserve price and the right of first refusal serve to elicit more aggressive bids and hence, to a certain degree, are substitute tools. Generally, a reserve price will exacerbate asymmetry, while a right of first refusal will reduce asymmetry.