Working Papers,
Copenhagen Business School, Department of Finance

Abstract: We conduct an analysis of legal pre-emption rights in which a beneficiary has a right but not an obligation to acquire a specific good at a certain price. We analyse how such an option influences seller and other prospective buyers. Furthermore, we address the question of the efficiency loss if the option holder cannot use his option and then sell the asset to the person with the highest reservation price. We model a sealed second bid auction with uniformly distributed subjective values. We show that the option leads to an expected loss for the other bidders as well as the seller and a total efficiency loss for society. The efficiency loss is born by the other bidders and amounts to fifty percent of the redistribution from the seller to the person who gets the option. The results are almost similar when introducing bidders with subjective values drawn from a normal distribution.

Keywords: Call-options; Efficiency loss; Redistribution

JEL-codes: G00

24 pages, December 1, 2001

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