High Bids and Broke Winners

This paper analyzes auctions where budget-constrained bidders have options to declare bankruptcy. It predicts a bidding equilibrium that changes discontinuously in a borrowing rate available to bidders. When the borrowing rate is above a threshold, high-budget bidders win, and the likelihood of bankruptcy is low. When the borrowing rate is below the threshold, the winner is the most budget-constrained bidder and is most likely to declare bankruptcy. This result explains the ``high bids and broke winners'' anomaly in the C-Block FCC spectrum auction. Based on its equilibrium analysis, the paper proves that a seller can profit from offering to finance the highest bidder at a below-market interest rate, even with default risk. Journal of Economic Literature Classification Numbers: D44, D45, D82, G33, L96. 2001