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An Examination of the Efficiency of Resource Allocation Auctions Within Firms
Stanley Baiman, Wharton School University of Pennsylvania
Paul Fischer, Pennsylvania State University
Madhav V. Rajan, Stanford University
Richard E Saouma, University of California Los Angeles
ABSTRACT. We study the optimal design of managerial incentives when resources are allocated by an internal auction market, as well as the efficiency of the resulting resource allocations. We show that the internal auction market can achieve first-best resource allocations and decisions, but only at an excessive cost in compensation payments. We identify conditions under which the internal auction market and associated optimal incentive contracts achieve the benchmark second-best outcome; the advantage of the auction is that it is easier to implement than the direct revelation mechanism. When the internal auction mechanism is unable to achieve second-best, we characterize the factors that determine the magnitude of the shortfall. Overall, our results speak to the robust performance of relatively simple market mechanisms and associated incentive systems in resolving resource allocation problems within firms.
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