The 40% Handicap Auction

Abstract

We study efficient license provisions when a government allocates a second license to operate in a monopoly market where a demand function and firms' cost functions are linear. Firms have different marginal costs, and depending on these costs, either a monopoly or a duopoly can be efficient. We show that an extremely simple mechanism that does not depend on the detailed information about the market achieves efficiency. Namely, the 40% handicap auction, a modified English auction in which a newcomer that wins a license has to pay only 40% of the winning price, always achieves an efficient market structure. Our benchmark results are extended in general cases that introduce fixed costs, increase the number of incumbents, and incorporate general social welfare functions.

Keywords: auction, entry regulation, handicap, license auction

JEL Classification: D44, D45, L51