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By: Bloomfield and Luft Presenter: Sara Aliabadi October,9, 2008 1.

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1 By: Bloomfield and Luft Presenter: Sara Aliabadi October,9, 2008 1

2 Can feedback from repeated competitive bidding markets teach people to bid well above estimated costs to avoid the winner’s curse? 2

3 The Winner’s Curse  What is winner curse?  Cooper 1989; Cooper et al. 1992; Turney and Ittner 1993; Hilton 2005 Define Winner’s curse: Firms win market share but lose money on products or services that are priced too low because their cost is underestimated. 3

4 Why Winner’s Curse happen?  Winner curse happens because sellers fail to recognize that bidder with lowest costs estimate is likely to have the largest cost underestimate.  This is because cost is underestimated and bidder has to bid even lower than the cost to win.  Equilibrium strategy is to pad bids enough to make a satisfactory expected profit conditional on winning the bid.  Prior studies show that sellers fail to pad bids enough to eliminate the winner’s curse completely. 4

5 Hypothesis Development The optimal amount of padding depends on sellers’ beliefs about their competitive position. Managers can sometimes use feedback to identify and adjust for the winner’s curse. The winner’s cruse has been shown to persist with professional bidders. 5

6 Hypothesis Development  Attribution Biases  Research in psychology has extensively documented self- serving attribution bias, i.e., individuals’ tendency to take credit for success and attribute failure to factors out of their control.  Sellers with responsibility for cost management will be less willing to attribute losses to high actual costs. 6

7 Hypothesis We predict that sellers with responsibility for both bidding and cost management will learn to increase padding more slowly than those who have responsibility only for bidding. H: Compared to sellers who are responsible for only pricing decisions, sellers who are responsible for both pricing and cost-management decision learn less well from market feedback to avoid the winner’s curse. 7

8 Overview and Experimental Design WE have 64 M.B.A. students. Students participated as sellers in auctions for production jobs. Participants are randomly assigned to a “responsibility” setting choose their own cost-management initiatives based on information about the initiatives’ past performance. Sellers received an estimate of their product cost. 8

9 Overview and Experimental Design  Sellers bid on contracts for large complex projects,  Estimated project costs includes error,  Seller’s firms undertake cost-management initiatives that are intended to increase their cost advantage. 9

10 Prior studies VS this study In this study we do not inform participants of the parameters of the setting; rather, sellers must learn parameters of setting from experience. They should attribute past bids and earnings outcomes to either noise in cost estimates or variation in competitive advantages. prior studies had participants bid on asset with a common cost or value. Winning the auction provides a strong signal that one’s estimate of cost or value is too optimistic. 10

11 Bidding and Feedback In each period, participants learned their own estimated costs and entered bids. After each round of trading, participants learned whether they personally entered the winning bid, and the earnings of the winning bidder. We provide extremely informative feedback to maximize the extent of learning over the course of the session. 11

12 Results To test our hypothesis: We examine the extent to which sellers “pad” their bids by bidding above the estimated cost provided by their cost accounting system. (Pad = bid – estimated cost) We test the seller’s mean padding over different periods. Figure 3 and Table 1show evidence that sellers learn to increase their padding and do so more effectively in the no-responsibility setting. 12

13 Analysis of Learning from Feedback How responsibility for cost management affects sellers’ period-by-period learning from feedback? We use the following regression: PadChange = F(Cohortprofit, WinDum, Cohorprofit*WinDum) Where : PadChange = change in padding of bidder i from period t-1 CohortProfit = profit of low bidder in cohort in period t-1 WinDum = a dummy varialbe 13

14 Result of Regression Table 2: responsibility and no-responsibility sellers react differently to the magnitude of prior-period losses. In both conditions, the more money a bidder loses in period t-1, the more other sellers increase their padding in period t. Seller who feel responsibility for their competitive advantage will have difficulty learning from feedback. 14

15 Discussion Prior research show that individual can learn from feedback to adjust for error in cost estimation. Individual in prior studies made decision relating price only. We compare performance of individuals with responsibility for pricing decision and for cost- management decision. 15

16 Discussion Continued Market feedback eliminates the curse of sellers who make only pricing decisions. Sellers with cost-management responsibility spend longer on the pricing but are not successful in improving their pricing decision. The effect we observe are related to escalation bias. We show that accounting-related decision errors will not be eliminated through market discipline. 16

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