An experimental study of jump bidding in auctions with entry costs

This paper provides an experimental test of jump bidding and signaling in takeover auctions. It follows the takeover auction design of Fishman (“A Theory of Preemptive Takeover Bidding,” The Rand Journal of Economics, 1988) which models takeover auctions as private value English auctions with entry costs and sequential entry. Fishman (1988) shows that in the presents of entry costs the first bidder with high private valuation of the object may place jump bids in order to signal his high value and deter potential competition. 

In this paper we present the results of the experimental study that is closely related to the takeover auction model developed by Fishman (1988). We have conducted 16 sessions that were divided into 3 treatments (high, low and zero entry costs) with 14-20 students in each. In each sessions subjects played 40 rounds of the following game:

The game: Two bidders compete for a fictional item. At the beginning of the auction bidder #1 spends non-refundable entry costs $C, observes his private value of the object S₁, which is uniformly distributed on [$0, $200] interval, and places an opening bid B₁. Bidder #2 observes the opening bid B₁ placed by the first bidder and decides if he wants to enter the auction. If he does not enter, he receives $0 and bidder #1 wins the auction for the price equal to his initial bid B₁. If he enters, he spends non-refundable entry costs $C and observes his private value of the object S₂, which is independent on S₁ and uniformly distributed on [$0, $200] interval. After that, the bidder with the highest value wins the object for the price equal to the maximum between the other bidder’s value and the opening bid, while the other bidder loses $C.

Prior to each round subjects were randomly divided into pairs and randomly assigned their roles (“bidder #1” or “bidder #2”). At the end of each round each subject was given the information about his opponent’s strategy and the outcome of the auction. All subjects were given monetary compensation based on their performance.

We show that in the presence of entry costs the first bidder places jump bids that deter the second bidder from entering. By conducting two treatments with high and low entry costs, we show that first bidders in low-costs auctions place preemptive bids less often but the size of such bids is generally higher that in auctions with high entry costs. The second bidders in low-costs auctions enter more often and higher jump bids are required to preempt them from entering. We also analyze the wealth distribution and social welfare implications of jump bidding. We show that jump bidding leads to the wealth redistribution from the seller to the bidders but have little effect on the social welfare. We also document that the first bidder receives significantly higher profit than the second bidder. All these evidence are consistent with the qualitative predictions of the signaling jump bidding model of Fishman (1988).