The value of a fallback option
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Fallback options are relatively common in the business context. If for example a firm fails to acquire a certain target firm—a first-best solution—it may decide to attempt the acquisition of another takeover target—a second best solution. When a decision maker tries to obtain the first-best solution, she may frequently choose different levels of effort to invest into its pursuit. This level of effort is generally influenced by the availability of a fallback option in case she fails to succeed in obtaining her first-best solution. Using a second price auction mechanism, we experimentally test whether subjects react to the existence and attractiveness of this fallback option by changing their bidding behavior. Our results show that subjects only partially adjust to the existence of the fallback option according to the theoretical prediction.
KeywordsFallback option Second price auction Bidding behavior
Mathematics Subject ClassificationD44
We are grateful to two anonymous referees, Nobuyuki Hanaki, and Jason Shachat for valuable comments. We furthermore thank audiences at the Experimental Finance 2013 in Tilburg and at the ESA World Meeting 2013 in Zurich for valuable comments. Last but not least, we thank Jakob Eichberger for his excellent research assistance.
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