Collusion and signaling in auctions with interdependent values

The standard mechanism design approach to collusion in auctions posits an uninformed, disinterested third party who designs and implements the mechanism. However, in many environments, collusion agreements are likely to be both proposed and executed by the involved parties. When this is the case, the standard approach may be inadequate; it neglects potential information leakages and minimizes frictions. We model collusion in a second-price auction by having one informed bidder propose to another. Bidders’ valuations are allowed to be interdependent and their private signals affiliated. In contrast to usual approaches to modeling collusion, we find that all-inclusive cartels will be unable to extract all of the surplus from the seller, and equilibrium outcomes will generally be (socially) inefficient. While both bidders are better off than without colluding, we exhibit a first-mover (relative) disadvantage: information leakages and a corresponding “winner’s curse” cause the proposer to be worse off than the receiver. Introducing outside competition compounds this winner’s curse and reduces the potential gains to collusion, resulting in substantially higher revenues for the seller.