Bidding More Aggressively or Free Riding? Theoretical and Experimental Analysis of Auctions with Negative Externalities

This paper studies negative externalities’e¤ect on bidding strategy and auction outcome. We use a model of one special bidder and two regular bidders, where if the special bidder wins, both regular bidders incur a loss; otherwise, the two losing bidders receive zero payo¤s. Applying the model to an ascending clock auction, regular bidders are shown to bid less aggressively and drop out before reaching their private values. A regular bidder may have to bid above his value in order to win against the special bidder and thus risks negative pro…t by bidding aggressively. Since both regular bidders avoid the externality if either wins, there is a free riding incentive to drop out early; once one of the regular bidders drops out, however, the remaining one bids aggressively. Despite free riding, the item is ex post e¢ ciently assigned in most cases. In contrast, in …rst-price sealed bid auctions free riding and aggressive bidding incentives are simultaneous, so ex post e¢ ciency is less frequent. Using experiments to test the theory, our results suggest that bidders more often exhibit aggressive bidding rather than free riding in an ascending clock auction; furthermore, we show that in …rst-price sealed bid auctions, regular bidders bid more aggressively than the special bidder, indicating aggressive bidding incentives dominate free riding incentives. Keywords: Auction; externality; free riding; aggressive bidding; experiment. JEL Classi…cation Numbers: D44, C91. Address: 410 Arps Hall, 1945 North High Street, Columbus, OH 43202, USA, telephone: 1-614-886-2439, e-mail: [email protected].