Lessons from a Failed Airline Auction

By Meister, J. Patrick; Anderson, Kyle J. | Economic Inquiry, April 2006 | Go to article overview

Lessons from a Failed Airline Auction


Meister, J. Patrick, Anderson, Kyle J., Economic Inquiry


I. INTRODUCTION

In October 1995, USAir (the United States' fifth-largest airline at the time) approached American Airlines first and then United Airlines about a possible buyout. American declined to bid, as did United. However, Ziemba (1995) reported that Robert Crandall, chair and CEO of American, indicated that American would have no alternative but to counterbid for USAir if United placed a bid. Thus, bidding and counterbidding were clearly possible, and an English auction (open oral, ascending) was being employed. Interestingly, because neither American nor United made a bid, USAir did not sell.

We show how this can happen even if the firm available for sale is worth more to the potential buyers than the available firm's reservation price. One key is what happens to a firm's profit if it loses the auction (i.e., two of its rivals merge). This work is related to the "auctions with externalities" literature, as in Jehiel and Moldovanu (1995, 1996) and Jehiel et al. (1996). Jehiel and Moldovanu (1996) focus on negative externalities exerted by the winning firm. In that case, in equilibrium, some firms may strategically commit not to bid in a sealed-bid auction. The object of the auction still sells, but firms that do not participate cannot avoid the negative externality. Our work adds the following insights. We analyze English auctions--unlike Jehiel and Moldovanu (1996)--and show that if losing the auction reduces a potential buyer's profit, then the available firm may actually fail to sell in equilibrium, whereas it would sell in a sealed-bid auction in which buyers cannot credibly commit not to participate. In the English auction, firms refrain from bidding if they realize that once the bidding starts, it will escalate into a profit-reducing bidding war. Intuitively, if bidding starts, firms bid offensively to get the gain from acquiring the available firm and defensively to avoid losing profit as a consequence of its rival obtaining the firm. Recall that Robert Crandall indicated that American would have no alternative but to counterbid for USAir if United placed a bid. The model in this article has the property described by Crandall. Second, we analyze cases where the "winning" firm confers positive profit externalities on the "losing" firm. In this case, the bidding starts (and the available firm sells) in an English auction because, even if a firm loses, its profit rises. Third, because of the prior insights, if an available firm fails to sell (and other conditions of the model are met), it might be considered evidence that a merger would reduce an outside firm's profit.

Finally, a novel aspect of how we model externalities in auctions highlights an important cause of bidding wars. Specifically, in our model the losing firm's profit not only changes because of losing but also increases with the price that the winner pays. The latter phenomenon may occur if paying a higher price puts more financial strain on the winner, thereby limiting its ability to make competitive improvements or strategic moves in the future. One may object to this because economic theory would say that once a competitor buys an asset, it immediately becomes (to some degree) a sunk cost and does not affect the output or strategic decisions of that firm. If capital markets are perfect, firms should be able to subsequently finance profitable strategic moves. (In such cases, the size of the winning bid should not typically affect the loser's long-run profit.) However, we have chosen to focus on cases for which a higher winning price limits the winner's future strategic moves and thereby negatively affects its profit (and positively affects the loser's profit). Perhaps capital markets are not perfect. Thus, the phenomenon of the size of the winning price affecting future strategic moves may arise more often than one might think. Airlines, for instance, are perpetually strapped for capital, and any increase in operations requires significant capital. …

The rest of this article is only available to active members of Questia

Already a member? Log in now.

Notes for this article

Add a new note
If you are trying to select text to create highlights or citations, remember that you must now click or tap on the first word, and then click or tap on the last word.
One moment ...
Default project is now your active project.
Project items

Items saved from this article

This article has been saved
Highlights (0)
Some of your highlights are legacy items.

Highlights saved before July 30, 2012 will not be displayed on their respective source pages.

You can easily re-create the highlights by opening the book page or article, selecting the text, and clicking “Highlight.”

Citations (0)
Some of your citations are legacy items.

Any citation created before July 30, 2012 will labeled as a “Cited page.” New citations will be saved as cited passages, pages or articles.

We also added the ability to view new citations from your projects or the book or article where you created them.

Notes (0)
Bookmarks (0)

You have no saved items from this article

Project items include:
  • Saved book/article
  • Highlights
  • Quotes/citations
  • Notes
  • Bookmarks
Notes
Cite this article

Cited article

Style
Citations are available only to our active members.
Buy instant access to cite pages or passages in MLA, APA and Chicago citation styles.

(Einhorn, 1992, p. 25)

(Einhorn 25)

1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

Cited article

Lessons from a Failed Airline Auction
Settings

Settings

Typeface
Text size Smaller Larger Reset View mode
Search within

Search within this article

Look up

Look up a word

  • Dictionary
  • Thesaurus
Please submit a word or phrase above.
Print this page

Print this page

Why can't I print more than one page at a time?

Help
Full screen

matching results for page

    Questia reader help

    How to highlight and cite specific passages

    1. Click or tap the first word you want to select.
    2. Click or tap the last word you want to select, and you’ll see everything in between get selected.
    3. You’ll then get a menu of options like creating a highlight or a citation from that passage of text.

    OK, got it!

    Cited passage

    Style
    Citations are available only to our active members.
    Buy instant access to cite pages or passages in MLA, APA and Chicago citation styles.

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn, 1992, p. 25).

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn 25)

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences."1

    1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

    Cited passage

    Thanks for trying Questia!

    Please continue trying out our research tools, but please note, full functionality is available only to our active members.

    Your work will be lost once you leave this Web page.

    Buy instant access to save your work.

    Already a member? Log in now.

    Oops!

    An unknown error has occurred. Please click the button below to reload the page. If the problem persists, please try again in a little while.