Reallocation Costs and Efficiency

We study the efficient allocation of a divisible asset when reallocation is costly. Each of two players is initially allocated a share of the asset. At the time of this initial division the players’ valuations for the asset are uncertain. After the uncertainty resolves, costly reallocation may take place. Reallocation costs may depend on the amount reallocated and on players’ valuations. We first observe that contracting on the initial division and the reallocation enables the players to attain the highest possible expected surplus for the specified initial division. Our main result then establishes that this maximal expected surplus either monotonically increases or monotonically decreases in the concentration of the initial division for a wide range of reallocation cost specifications. ∗We thank David Besanko, Eddie Dekel, Kfir Eliaz, Alex Gershkov, Tzachi Gilboa, Ed Lazear, Margaret Meyer, Benny Moldovanu, John Moore, Marco Ottaviani, Alessandro Pavan, Nicola Persico, Bill Rogerson, Larry Samuelson, Rani Spiegler, Rakesh Vohra, Asher Wolinsky, and seminar participants at Bocconi, the Bounded Rationality Conference in Jerusalem, Cambridge, Contests, Mechanisms, and Experiments Conference in Exeter, Hebrew University, IDC, LSE, Michigan, Minnesota, NYU Stern, Northwestern, Ohio State, Oxford, Princeton, Purdue, Tel-Aviv, Warwick, and Wisconsin for helpful comments and suggestions. The second author thanks Tel-Aviv University and Hebrew University for their hospitality. †Email: [email protected] and [email protected]