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License Bidding – Sunk Costs that Matter

In this paper, we investigate the role of sunk costs in affecting subsequent actions. With the assumptions that bankruptcy laws limit a firm’s liability and that the demand is uncertain when a firm sets its price, we examine a few situations where lump-sum payments affect a firm’s decision after these payments are sunk. In the case of one license, the winning firm becomes a monopoly and its monopoly price is increasing in what it pays in the auction. In the case of two licenses, the two winning firms will compete in the product market. In this case, a higher bid from one firm provides positive externality to all other firms. Furthermore, the seller can control the number of licenses for sale to maximize its revenue. In all cases, we find that bids are extremely high in the English auction, and it always generates more revenue to the seller than a discriminatory auction. Finally, in an appendix, we study yet another situation where positive externality is present. JEL Classification Numbers: D44