Gordon V. Karels

The Competitive Effect in Bonus Bidding: New Evidence

One of the major unsettled questions in the study of competitive bidding concerns the impact of additional competition in auctions on the optimal bid levels of competing firms. Numerous theoretical and simulation studies suggest an inverse relationship between the expected number of competitors and the bid level of a particular firm in sealed bid auctions involving objects of uncertain value. The few empirical studies that have been done contradict this assertion. In this article, we address this issue by pointing out a serious statistical defect in previous empirical work and by reestimating a bid level equation by using a more appropriate technique. New evidence is provided which reconciles the differences between previous empirical results and the major predictions of the widely accepted bidding theory models. The new results presented here support the conclusions of the theoretical studies.

Efficient rents 1 rent-seeking behavior in the long-run

Summary and implicationsWe have analyzed long-run behavior in rent-seeking under several conditions and behavioral hypotheses. The question of interest is whether or not the long-run expenditures will exactly equal the value of the rents. Our results depend on the type of competitive response which is assumed to exist in the long-run and on the r-value governing the probability of winning.For the case where the r-value is less than or equal to one, Tullock has pointed out that aggregate expenditures will always be less than the value of the game. The long-run solution, however, results in each firm submitting an infinitesimal bid — not a very realistic solution. We showed that when a minium bet requirement is imposed, the number of players is determined in the long-run, and all rents will be dissipated if the minimum bet is integer divisible into the payoff. If not, aggregate expenditures depend upon the size of the minimum bet relative to the total payoff; however, the tendency towards complete dissipation of expected profits still exists.For r-values greater than one we looked at entry under hit and run and hardball competition. Under hit and run competition entry occurs if the potential entrant can make positive expected profit. In the long-run this suggests that incumbents make their bets to pre-empt potential competition. We found a range of possible pre-emptory bets. Using this range we considered the Cournot-Nash and the collusion solutions. For both cases the hit and run entry assumption allows various numbers of incumbents to be a stable equilibrium. For high r-values, however, only one player can exist. Aggregate expenditures under both kinds of solutions dissipate the greater part but not all of the available rents. As the number of players is increased greater dissipation of the rents results.Hardball competition was defined as entry occurring so long as accommodation could be forced by imposing expected losses on the incumbents if accommodation and resulting expected profits for the entrant are not obtained. This would require the potential entrant to be willing to absorb a short-run loss. If this type of entry is carried out, the number of players increases to the point where the minimum pre-emptory bid yields a negative expected profit for the players. The number of players will thus depend upon the r-value. The rents will always be very nearly dissipated in hardball competition whether the incumbents collude or settle at the C-N solution initially.These results assume the payoff is known with certainty and is treated as if the game is continually replayed. Since all players were assumed identical, the long-run results could also be considered the solution where each possible player has timeto consider alternatives and signal ‘precommittal’ behavior.It is perhaps interesting that the results concerning hardball competition are similar in nature to those obtained in the monopoly analysis of Baumol, Panzar and Willig (1982) on potential competition. They find that the presence of potential competition dissipates monopoly profits under certainty and non-increasing average costs. This is very similar to our findings that rents are nearly dissipated with the potential for entry if the entrant would be willing to accept short-run losses.Given the social objective to minimize the expenditure of resources in rent-seeking the following are implied by our results:1.Dissallowing any type of entry and minimizing the number of players will hold down the aggregate expenditure of resources. Further reductions will be obtained if collusion is encouraged allowing players to place the minimum bet to maximize expected profits.2.If entry cannot be disallowed then regulate against hardball competition whereby entrants incur short-run expected losses to gain accommodation by incumbents. Here again collusion is preferable, not only because it results in minimum expenditures by each incumbent but also because the C-N solution is unstable at low numbers of players for certain r-values and hit and run entry will result.3.If hardball entry cannot be prevented then encouraging competition among the incumbents with a likely C-N solution appears to be marginally preferable to allowing collusion.4.Application of a lump sum cost as a condition for participating in the rent-seeking process, e.g., a license, will reduce the total expenditure in rent-seeking by an equal amount.