OPTIMAL AUCTION DESIGN AND RESEARCH-AND-DEVELOPMENT

An indivisible object is to be procured through bidding from one of tw o prospective suppliers. Firms decide whether to invest in cost-reduct ion before the bidding. The procurer commits to a mechanism ahead of i nvestment decisions by firms. If the procurer can charge entry fees th at may be discriminatory, a sealed-bid second-price auction uniquely i mplements the first-best outcome and is optimal for the buyer. 'Revenu e Equivalence' holds when first-best investments are symmetric; howeve r, it breaks down when first-best investments are asymmetric. Without entry fees, the procurer may want to bid-discriminate between ex-ante identical firms to induce the favored firm to invest and become strong while the unfavored firm not to invest and stay weak. This result run s counter to the earlier findings on discrimination in procurement auc tions without pre-contract R&D: the principal favors the weaker agent to induce stronger bid competition. (C) 1997 Elsevier Science B.V.