This paper draws a remarkably simple bridge between auction theory and incentive theory. It considers the auctioning of an indivisible project among several fi rms. The firms have private information about their future cost at th e bidding stage, and the selected firm ex post invests in cost reduct ion. The authors show that (1) the optimal auction can be implemented by a dominant strategy auction that uses information about both the first bid and the second bid; (2) the winner faces a (linear) incenti ve contract; (3) the fixed transfer to the winner decreases with his announced expected cost and increases with the second lowest announce d expected cost; and (4) the share of cost overruns borne by the winn er decreases with the winner's announced expected cost.

We consider two kinds of “outside opportunity” that a seller of an indivisible good might have: selling to a different buyer and consuming the good herself. In both models the seller is uncertain about the buyer's valuation, and becomes more pessimistic over time. When the seller becomes sufficiently pessimistic, she prefers the outside opportunity, so she will not bargain indefinitely with the current buyer. Despite the resulting finite-horizon nature of negotiations, the link between the buyer's willingness to accept an offer and the seller's eagerness to go “outside” generates multiple equilibria.