On the Right-of-First-Refusal
37 Pages Posted: 24 Nov 2004
Date Written: June 2002
When the seller of an asset grants a right-of-first-refusal to a buyer, this special buyer has the opportunity to purchase the asset at the best price the seller can obtain from the other potential buyers. We show that the right-of-first-refusal is inefficient, and it benefits the special buyer at the expense of the seller and other buyers. In a private values model, the benefit the special buyer obtains via the right-of-first-refusal equals the cost to the seller. When buyers' valuations are correlated, the presence of a special buyer exacerbates the winner's curse on regular buyers. Consequently, the special buyer's expected gain from the right-of-first-refusal is often less than the expected loss to the seller. Thus, our analysis suggests that the seller should exercise considerable caution prior to deciding whether to grant this right to a buyer.
Keywords: Pricing, contracts, right-of-first-refusal, meet-the-competition clause
JEL Classification: D4, L11, L14
Suggested Citation: Suggested Citation