Goodwill Can Hurt: a Theoretical and Experimental Investigation of Return Policies in Auctions

Will generous return policies in auctions benefit bidders? We investigate this issue using second-price common-value auctions. Theoretically, we find that the bidding equilibrium is unique unless returns are free, in which case there exist multiple equilibria with different implications for sellers. Moreover, more generous return policies hurt bidders by eroding consumer surplus through higher bids. In the experiment, bids increase and bidders? earnings decrease with more generous return policies as predicted. With free returns, many bidders bid above the highest possible value, subsequently returning the item regardless of value. Though consistent with equilibrium behavior, this is not optimal for sellers.