Summary 667- A transaction is possible if and only if firm A (the buyer) is more
optimistic that the bill will be defeated (and, therefore, sees a higher
expected value for the facility) than is firm B. Firm A’s value, net of the
transaction cost, is (pA)(4) (1 pA)(3) .05, where pAis the firm’s
assessed probability that the bill will be defeated. In turn, firm B’s
minimum walk-away price is (pB)(4) (1 pB)(3) .05. Note that the
seller’s walk-away price is augmented by the transaction cost. After some
rearrangements, we find that firm A’s value is greater than firm B’s if and
only if pA pB.1. - The smaller the portion of risk he or she holds, the more risk neutral the
decision maker becomes. Thus, with risks split five ways, the gap between
the prospect’s expected value and its CE value (the sum of the CE values
of syndicate members) will shrink. If risk were shared by a large number
of members (say, 100), the individual risk would be trivial, and the total
CE value would approach the prospect’s expected value. - Increasing purity by 1 percent has a MC to Firm A of $50,000. For Firm B,
the extra benefit is $80,000 (going from 97% to 98%) and $40,000 (going
from 98% to 99%). The change to 98% increases total value (because
MB MC), but a further increase to 99% does not make sense (MC MB).
Therefore, 98% is the efficient outcome.
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