Efficient collusion in optimal auctions

We study collusion in an IPV auction with binary type spaces. Collusion is organized by a third party that can manipulate participation decisions. We characterize the optimal response of the seller to different threats of collusion among the bidders. We show that, contrary to the prevailing view that asymmetric information imposes transaction costs in side contracting, collusion in the optimal auction is efficient when the third party can implement monetary transfers as well as when it can implement monetary transfers and reallocations of the good. The threat of non-participation in the auction by a subset of bidders is crucial in constraining the seller's profit. (C) 2006 Elsevier Inc. All rights reserved.