A Laboratory Test of an Auction with Negative Externalities

We examine experimentally an auction model with externalities in which competing firms bid for licenses to a cost-reducing technology. Since winning bidders impose a negative externality on the losers, bids must account for both the value of winning the auction and the negative value of losing brought about by rivals reducing their costs. Experimental treatments differ in the severity of the negative externality (based on the substitutability of competitors’ products), and the number of licenses being auctioned. We find that subjects underbid relative to theoretical benchmarks for auctions of one license, but overbid when two licenses are auctioned. Nevertheless, mean revenues in the experiment are consistent with the predicted revenues. However, there are some differences between the distributions of experimental and predicted revenues. We propose a possible explanation for these differences rooted in a simple bidding heuristic. JEL Classification Numbers: D44, D45, L13