bidders are still able to earn positive profits on average. Overbidding in sealed-
bid auctions is even more pronounced. With a small number of competitors
(three or four), winning buyers tend to overbid but still earn a small positive
profit on average. However, facing many competing bidders (six or more), buy-
ers increase their bids (contrary to the correct response of decreasing bids) and
consistently fall prey to the winner’s curse. That is, they suffer significant losses
by overpaying for the items they win.
There is evidence of the winner’s curse in many real-life competitive bid-
ding settings. In competitive procurements, it is commonly held that the win-
ner simply may be the most optimistic firm (the one that most grossly
underestimated the true cost of the job) rather than the most efficient one.
The evidence of frequent cost overruns is due partly to the winner’s curse and
partly to poor contract incentives to minimize costs. Estimates in the 1970s
and 1980s suggest that the U.S. government has received close to full value for
its offshore oil leases. In aggregate, tract winners have earned only modest
profits. Moreover, on tracts with six or more bidders, winning bidders have
suffered losses on average. The winner’s curse is frequently evident in the bid-
ding for free agents in Major League Baseball and in the unprecedented
prices paid in corporate takeovers involving multiple bidders. (By paying too
high a price, the winning acquirer suffers a worsening in financial perform-
ance over an extended period following the acquisition.) Finally, a predictable
proportion of buyers overbid in online auctions. (In many online auctions,
buyers have the option to “Buy It Now” at a fixed price, rather than enter the
auction. Yet, a fraction of winning auction bidders end up paying in excess of
the buy-it-now price!)
How do sellersfare in various real-world bidding settings? In line with
auction theory, the overwhelming research evidence is that increasing the
number of bidders (see Figure 16.3) significantly raises expected seller rev-
enues. In short, as sellers well know, one key to a successful auction is mar-
keting—publicizing the sale, approaching likely buyers, and ensuring they
enter the auction. Second, in actual practice, neither the English nor sealed-
bid auction appears to have a clear revenue advantage over the other. For
instance, revenue equivalence appears to be the norm in timber auctions
where both auction methods have been used. On the one hand, the ten-
dency of buyers to submit elevated sealed bids (due to risk aversion or win-
ner’s curse mistakes) would tend to favor sealed-bid auctions. However, in
some other settings, sealed-bid methods appear to underperform. For
instance, the United States Treasury has lowered its borrowing costs by mod-
ifying its procedure for auctioning treasury securities. Formerly, securities
were sold at auction to buyers who submitted bids requiring the lowest inter-
est returns (up to a cutoff interest rate), and each winner received the inter-
est rate it bid. Beginning in the 1990s, the U.S. Treasury has continued to
accept bids with the lowest interest rates, but now all winning bidders receive
the same interest return, namely, the highest accepted interest rate. The692 Chapter 16 Auctions and Competitive Biddingc16AuctionsandCompetitiveBidding.qxd 9/26/11 1:09 PM Page 692