The Winner's Curse By Paul Milgrom In The Auction Theory
The “Winner’s Curse” is a phenomenon that occurs when a bidder in an auction pays more (often much more) than the value of the item being won. Paul Milgrom of Stanford University, a leading auction scholar, defines more precisely the Winner’s Curse as
“The winner’s curse in auction theory traditionally refers to the selection bias that arises because a bidder tends to win more often when his value estimate is too high than when it is too low.”
This phenomenon occurs in auctions, irrespective of auction type, when a common value object is being auctioned. Here, the value of the object being auctioned is approximately common or the same (within a narrow range) for all bidders participating in the auction.
What cause the Winner’s Curse? The …show more content…
Can it be avoided? The strategy to avoid the Winner’s Curse revolves around two major …show more content…
The winner of the auction must bid $2.5 per share more than the other bidder (with this margin reducing as a function of time), else they both have to continue until this criteria is met . Unaware of the other party’s bid, each participant made a move trying to guess the amount it needs to be the winner. The chronology of the bidding process started by Pilgrim Pride bidding at $45 per share; this was topped by a bid of $50 per share by Tyson, followed by a $55 per share bid by Pilgrim Pride. In an effort to secure the deal Tyson decide to up bid Pilgrim Pride, this time offering $63 per share. At this point Pilgrim Pride CEO Bill Lovette gave up bidding and said “As a disciplined acquirer, we determined that it is in best interest of our shareholders not to increase our proposed price of $55 per share” . As it turn out, Tyson offer represented 70% premium of Hillshire share price before the start of the bidding war, and that, it could have won the auction by just offering $57.5 per share saving almost $500M of the total price it paid for the deal ( $7.7B). This is not including an additional $163M Tyson had to pay as penalty to release Hillshire out of a previous deal it struck to buy Pinnacle foods a month earlier that Tyson was not interested
“The winner’s curse in auction theory traditionally refers to the selection bias that arises because a bidder tends to win more often when his value estimate is too high than when it is too low.”
This phenomenon occurs in auctions, irrespective of auction type, when a common value object is being auctioned. Here, the value of the object being auctioned is approximately common or the same (within a narrow range) for all bidders participating in the auction.
What cause the Winner’s Curse? The …show more content…
Can it be avoided? The strategy to avoid the Winner’s Curse revolves around two major …show more content…
The winner of the auction must bid $2.5 per share more than the other bidder (with this margin reducing as a function of time), else they both have to continue until this criteria is met . Unaware of the other party’s bid, each participant made a move trying to guess the amount it needs to be the winner. The chronology of the bidding process started by Pilgrim Pride bidding at $45 per share; this was topped by a bid of $50 per share by Tyson, followed by a $55 per share bid by Pilgrim Pride. In an effort to secure the deal Tyson decide to up bid Pilgrim Pride, this time offering $63 per share. At this point Pilgrim Pride CEO Bill Lovette gave up bidding and said “As a disciplined acquirer, we determined that it is in best interest of our shareholders not to increase our proposed price of $55 per share” . As it turn out, Tyson offer represented 70% premium of Hillshire share price before the start of the bidding war, and that, it could have won the auction by just offering $57.5 per share saving almost $500M of the total price it paid for the deal ( $7.7B). This is not including an additional $163M Tyson had to pay as penalty to release Hillshire out of a previous deal it struck to buy Pinnacle foods a month earlier that Tyson was not interested