Auction Design with Fairness Concerns : Subsidies vs . Set - Asides ∗

Government procurement and allocation programs often use subsidies and set-asides favoring small businesses and other target groups to address fairness concerns.These concerns are in addition to standard objectives such as efficiency and revenue.We study the design of the optimal mechanism for a seller concerned with efficiency,subject to a constraint to favor a target group. In our model, buyers’ private valuesare determined by costly pre-auction investment. If the constraint is distributional,i.e. to guarantee that the target group wins ‘sufficiently often’, then the constrainedefficient mechanism is a flat subsidy. This is consistent with findings in the empiricalliterature. In contrast, if the constraint is to ensure a certain investment level by thetarget group, the optimal mechanism is a type dependent subsidy. In this case a setaside may be better than a flat or percentage subsidy. ∗The authors would like to thank seminar audiences at the University of Toronto, and University ofWestern Ontario.†Department of Economics, University of Pennsylvania. Email: [email protected].‡Managerial Economics and Decision Sciences, Kellogg School of Management, Northwestern University.Email: [email protected].