There's a Name for Why the Winners in an Auction Often Overpay - Pacific Standard

There's a Name for Why the Winners in an Auction Often Overpay

A phenomenon discovered by oil engineers after they spent too much on tracts of land in the Alaskan tundra also applies to all of those eBay bidding wars you've been participating in.
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(Photo: chrupka/Shutterstock)

(Photo: chrupka/Shutterstock)

Next time you throw a party, try filling a jar with coins and auctioning it off to your guests. Research suggests you’ll come out ahead: While the average bid will probably be lower than the coins’ cash value, the winning bid will likely be significantly higher. And the guest who takes home your jar of change will have suffered from what economists call “the winner’s curse.”

The curse was discovered on the Alaskan tundra in 1969. One of the largest oil deposits on Earth had just been found there, and the state decided to auction off drilling rights for several dozen tracts of land. The auction paid off beautifully for Alaska: The winning bids added up to $900 million. But a tally of the second-place bids indicated that the auction hadn’t gone so well for the oil companies: They added up to only $370 million.

Today we know it’s not just oil companies that are prone to overpay in a bidding war. Economists have since observed the winner’s curse in a variety of auction-like settings.

A trio of petroleum engineers who studied the auction found that the winners could have submitted bids a third lower and still won four out of five of the leases they sought. Why had big oil companies—some of the most calculating entities on Earth—overshot? “In competitive bidding,” the engineers theorized, “the winner tends to be the player who most overestimates true tract value.”

Today we know it’s not just oil companies that are prone to overpay in a bidding war. Economists have since observed the winner’s curse in a variety of auction-like settings: in the market for free agents in pro baseball, in corporate takeovers, and in sales of collectible coins on eBay. So take heart, losers. The winner doesn’t just take all. The winner also takes a loss.

This post originally appeared in the May/June 2014 issue ofPacific Standardas “The Winner's Curse.” For more, subscribe to our print magazine.

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