Right of First Refusal (ROFR) Effects in Auctions with Reserve Price: Empirical Evidence from Taiwanese Government Land Auctions

Abstract

The right-of-first-refusal (ROFR) granted by the seller to a buyer that allows the favored buyer to purchase the asset at the highest price the seller can obtain from other competing buyers is common in auctions and other economic transactions. Yet the predictions of the theory on the impact of this hybrid mechanism on auction outcomes have not been tested using real-world transaction data. Hence, our knowledge of the practical economic impact of this hybrid auction that decouples price formation and allocation on bidder behavior and ultimately expected seller revenue and profit is quite limited. This paper presents the first empirical evidence on the effects of ROFR from 1012 first-price sealed-bid auctions for the sale of government owned land in Taiwan from 2007 to 2010. The main findings are as follows. An auction with the ROFR has significant negative effect on auction success, i.e. it decreases the likelihood of asset sale. Further, we find that the presence of ROFR in an auction: (i) discourages bidder entry into auction, (ii) creates incentive for bidders to bid less aggressively, and (iii) ultimately reduces seller expected revenue and profit. Interestingly, in majority of the margins of auction outcomes we analyzed the reserve price tends to offset the effects of the ROFR, and the ROFR in turn has significant negative effect on the level of reserve price set by the seller. Overall, the weight of our empirical evidence provides support for the branch of the theory that predicts negative impact of ROFR on auction outcomes.

Keywords: auctions, right-of-first-refusal, mechanism design, reserve price, real estate

JEL Classification: D4, D44, D47, L11, D82, R3