DISINCENTIVISING OVERBIDDING FOR TOLL ROAD CONCESSIONS Figure A2.2 The winner’s curse with bid discounting Bids Estimates A B C E(Xi|Si)=V Source: Oxera. Rational bidders, maximising their expected utility, would lower their bids in order to allow <strong>for</strong> the bidding of competitors. 124 Through this strategic discounting of bids, the bidding distribution should be shifted far enough to the left such that the winning bidder will still be able to earn a rate of return on its investment. This is the case shown in Figure A2.3. Figure A2.3 Rational bidding to overcome the winner’s curse Bids Estimates Source: Oxera. E(Xi|Si)=V 124 Cox, J.C. and Isaac, R.M (1984), ‘In Search of the Winner’s Curse’, Economic Inquiry, 22:4, 579–92. 70
A2 │ THE WINNER’S CURSE Empirical evidence The winner’s curse was first observed from field data. Capen, Clapp and Campbell’s seminal article in 1971 introduced the concept into the literature. Box A2.1 Empirical evidence of the winner’s curse Between 1954 and 1970, oil and gas leases in the Outer Continental Shelf (off the coasts of Louisiana and Texas) were sold in US federal auctions. Capen, Clapp and Campbell (1971), and a later study by Mead, Moseidjord and Sorensen (1983), identified several interesting features of the competitive bidding process <strong>for</strong> these leases. •• The highest bid <strong>for</strong> a lease was frequently between five and ten times larger than the lowest bid. •• In 1969, winning bids amounted to $900m, while the aggregate of the second-highest bids was US$370m. •• The winning bid was at least twice as large as the second-highest bid <strong>for</strong> 77% of the leases. •• Across the 1,223 leases issued between 1954 and 1969, firms made a mean present-value loss of US$192,128 per lease (using a 12.5% discount rate). •• Only 22% of all leases were profitable. Source: Capen, Clapp and Campbell (1971), op. cit. Mead, W.J., Moseidjord, A. and Sorensen, P.E. (1983), ‘The Rate of Return Earned by Lessees under Cash Bonus Bidding of OCS Oil and Gas Leases’, The Energy Journal, 4, pp. 37–52. The winner’s curse has also been observed in laboratory settings in numerous studies. Bazerman and Samuelson (1983), <strong>for</strong> example, held studies in which MBA students made sealed bids <strong>for</strong> a jar of coins which, unbeknown to the subjects, had a value of $8 in each instance. 125 Interestingly, the mean estimate of the value of the jars was $5.13, representing an average underestimation of $2.87. As noted by the authors, this would be expected to reduce the likelihood and magnitude of the winner’s curse. In fact, the mean winning bid <strong>for</strong> the 48 auctions was $10.01, such that the winning bidder made on average a loss of $2.01. Moreover, losses were made in 26 of the auctions, and in 23 of these the losses were greater than $1. The authors thus concluded that: The evidence strongly indicates that individuals fail to take undertake the necessary inference and to adjust their bids accordingly. Thus while individuals recognize that uncertainty exists, they do not take this into account sufficiently when <strong>for</strong>mulating their bidding strategies. 126 Some important conclusions can be taken from the studies that have followed since. •• Learning over time—one argument might be that mistakes observed in <strong>toll</strong> <strong>road</strong> <strong>concessions</strong> to date could be attributable to the bidder’s inexperience and might be overcome in subsequent (repeated) interactions. Equally, it might be expected that early results would be sensitive to ‘a number of grossly inflated bids’ and that these might be expected to be eliminated over time as a result of bankruptcies. This was an early criticism of Bazerman and Samuelson’s study, but does not seem to have been borne out by later experimental work, where the winner’s curse has been observed to exist throughout repetitions. Thaler (1988), <strong>for</strong> example, says of one study of repeated auctions: There was no sign of any learning among the others; in fact the average bid drifted up over the last few trials. It may be possible to learn to avoid the winner’s curse in this problem, but the learning is neither easy nor fast. 127 125 Bazerman, M.H. and Samuelson, W.F. (1983), ‘I Won the Auction but Don’t Want the Prize’, The Journal of Conflict Resolution, 27:4, 618–34. 126 Bazerman and Samuelson (1983), op. cit., p. 631. 127 Thaler (1988), op. cit., p. 194. 71
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