What is Winner’s Curse and How to Overcome it?

The winner’s curse is a phenomenon or tendency of winning a bid in an auction with an exceeded value of the item. The actual value of the asset may be the same for different bidders. The winner’s curse occurs when the winner overpays for a specific asset. It can be said that even after winning, the winner may be in a worse-off situation because they ended up overpaying for the same asset. The term was coined by three Atlantic Richfield engineers who looked after the poor investment choices and bidding made for oil drilling rights in Mexico. The term is even related to Initial Public Offerings (IPOs) but is often used for all kinds of purchases made in action. Let us understand more about the winner’s curse and what can be done to overcome it. 

What Factors Contribute to Winner’s Curse? 

There can be different reasons that cause the winner’s curse in business and may impact the functioning of the firm. One needs to understand that the chances of a winner’s curse often increase with the growing number of bidders. It is common that more bidders may imply more amount, which can increase the chance of potential buyer facing losses. A variety of subjective factors, types of bidders, and emotional reasons may be some of the other concerns leading to the phenomenon. At times, the gap in auctioned value may be much higher than that of the intrinsic value.  

Let us understand this with the help of an example. The painting by a famous oil painter is in an auction, and the intrinsic value of the painting is $30K. Joe had raised the bid for $20K. Frank’s bid was $30K, whereas James’ bidding was $60K. It can be seen that James won the auction. However, he ended up paying $30K more or double the amount of intrinsic value. The highest bid always wins the auction, but James is at a loss as he ends up overpaying the amount of money. The bidders must be very strategic while making such decisions. Every potential buyer must analyze different aspects while making the bid. Bidding out of emotions and feelings can make it difficult and raise the risk of the winner’s curse.

Overcoming Winner’s Curse in Business 

As mentioned above, buyers should never bid without considering and analyzing the asset’s value. Here are some key aspects to keep in mind to overcome the winner’s curse. 

Assess Your Capabilities

The first and most important thing to keep in mind is to assess your own capabilities. You should be very specific about the assets you are bidding for as a bidder. Avoid bidding amounts that may be higher than your limits. You may even take some time to research and understand the capabilities of other bidders as well. Try to find out if any other bidder has a specific reason or emotion associated with that asset. In that case, it is likely that they may go with a higher amount. You should know your limits and stop bidding higher amounts that you cannot deal with. 

Common Value or Private Value

Another critical aspect to consider here is whether the asset has a standard value element attached to it. If the asset has equal value for everyone, the decision or amount for bidding should be made carefully. On the contrary, if you need the asset to fulfill some personal motives, you may consider going for a higher amount. At times, the buyers have emotions or family sentiments associated with the asset, which may increase the bidding. 

Consider Potential Outcomes

To overcome the winner’s curse, you also need to think strategically before making the bidding. Think about the potential outcomes if you win or lose the bidding. Ask yourself for that specific reason and why you want to win the bid so badly. You should avoid increasing the bid amount because of the personal equation with other bidders. Think whether you will be happy after winning the bid or if it will not affect you at all. Have a potential budget in mind before you visit the site for auction. No matter what, you should stick to your original decision and avoid bidding out of budget to overcome the winner’s curse. 

Compare Risks and Rewards

The above step may have allowed you to understand what the potential outcome could be. After determining that, you should take out time and compare the risks and rewards associated with each outcome. You must ask yourself if you are willing to take that risk and face the situation if you might end up in financial debt. Similarly, you must even consider the rewards of gaining ownership of that asset. Compare the risks and rewards properly. After a thorough evaluation, you should choose what you wish to proceed with. 

Take Decisions Wisely!

The winner may be at higher risk of being in financial losses and debts. There can be pros to buying the asset, but you should also weigh the cons associated with the same. The winner’s curse is a situation that can be prevented by making all the decisions strategically and carefully. As mentioned above, each buyer should compare and review each aspect carefully and then come to a conclusion.