To be or not to be cursed in an auction?

 “I Won the Auction but Don’t Want the Prize” was the title of the phenomenal article published in 1983 by  Max H. Bazerman and William F. Samuelson. (link) This article conducted one of the first studies that followed the 1971 Gulf of Mexico phenomenon discovered by petroleum engineers Edward Capen, Robert Clapp, and William Campbell. In that very reach in the oil (in those days) area, the company income was sufficiently low due to the sufficiently high winning bids on the mineral rights auctions. 

This interesting discovery leads us to a well-known issue that arises in many auctions: the “winners curse.”

The "winner's curse" is a phenomenon often encountered in auctions, particularly in situations where bidders have varying degrees of information about the item being auctioned. It occurs when the winning bid in an auction exceeds the intrinsic value or true worth of the item being auctioned. Essentially, the winner ends up overpaying due to factors like incomplete information, emotional bidding, or misjudgment of the item's value.

This concept is particularly relevant in auctions for things like real estate, mineral rights, art, or stocks, where there can be significant disparities in the perceived value of the item among bidders. The winner may feel like they've secured a victory, but if they've significantly overpaid compared to the item's actual worth, they may find themselves in a less advantageous position than they initially thought.

The winner's curse isn't just confined to traditional auction settings; it can also apply to other scenarios where there's competition to secure something valuable. For instance:

1. Corporate acquisitions: In the corporate world, when one company bids to acquire another, there's often a winner's curse at play. The acquiring company may end up overpaying if it overestimates the target company's value or fails to account for potential risks and liabilities.
2. Hiring processes: Employers might experience the winner's curse when they make an offer to a highly sought-after candidate. If they offer a salary significantly higher than the market rate or the candidate's true value to the company, they may find themselves with a new employee who expects more than they contribute.
3. Investments: Investors can fall victim to the winner's curse when they participate in hot markets or frenzied bidding for assets like stocks, cryptocurrencies, or real estate. FOMO (Fear of Missing Out) can lead them to bid up prices beyond the assets' intrinsic value, resulting in losses when the market corrects.
4. Government contracts: Governments award contracts to private companies for various projects. If a company overbids to secure a contract, it may face challenges in delivering the project within the agreed-upon budget or timeframe, leading to financial losses and reputational damage.

The main reasons that the “winner course” occurs are the degree of uncertainty and the size of the bidding population. 

Overcoming the winner's curse requires a combination of strategy (game theoretical approach), careful analysis, and discipline. Here are some approaches to mitigate its impact if we consider a company case:

1. Thorough research and analysis: Before participating in any competitive situation, whether it's an auction, acquisition, hiring process, or investment, conduct comprehensive research and analysis. Understand the underlying factors that determine value, assess potential risks, and gather as much information as possible about the item or opportunity in question. Remember that one of the main reasons for being “cursed” is the lack of information.
2. Set clear objectives and limits: Define your objectives and establish clear boundaries or limits on how much you're willing to pay, invest, or offer. Having predefined thresholds can help you avoid emotional decision-making and prevent you from exceeding your budget or overcommitting to a deal.
3. Utilize valuation techniques: Employ various valuation techniques appropriate to the situation, such as discounted cash flow analysis, comparable company analysis, or market research. These methods can provide a more objective assessment of the item's true value and help you make more informed decisions.
4. Consider asymmetric information: Be mindful of information asymmetry, where one party has more information than others. If you suspect that others may have better insights or information, factor this into your decision-making process and adjust your strategy accordingly.
5. Practice patience and discipline: Avoid succumbing to FOMO (Fear of Missing Out) or getting caught up in bidding wars. Maintain discipline and patience, and be prepared to walk away if the price exceeds your determined value or if the terms are not favorable.
6. Use game theory: In competitive situations, apply principles of game theory to anticipate others' actions and optimize your own strategy. Understanding the motivations and likely behaviors of other participants can help you position yourself more advantageously and avoid the winner's curse. In other, maybe more complicated words, know how to behave in equilibrium.
7. Seek expert advice: When in doubt, seek advice from professionals or experts in the relevant field, whether it's financial advisors, consultants, or industry specialists. Their expertise and insights can provide valuable perspectives and help you make more informed decisions. This returns back to the main problem of disinformation, which is one of the main reasons for the winners' curse.

By incorporating these approaches into your decision-making process, you can reduce the likelihood of falling victim to the winner's curse and make more effective, value-maximizing decisions in competitive situations.

Where do regular people and not companies meet the winner's course? In many cases. For example, when we want to buy a house, a car, or a piece of art at auction.

How can a regular person mitigate the winner curse effect? The answer to this case is quite simple. Assume that you chose the maximum bid you want to pay for the item sold (and you very much want it) in the auction. Additionally, let's assume that someone whispering to your ear that you will be the winner. Will you still place the bid in the amount that you have decided? If the answer is yes, bid it. Otherwise, you should consider revisiting your previous decision. And after the new maximum bid determent, returning to whispering.

The pictures in this post were taken from Unsplash.