Learning and the Possibility of Losing Own Money Reduce Overbidding : Delayed Payment in Experimental Auctions

In this study, we designed a delayed payment mechanism in laboratory second price auctions (SPAs) under which subjects received a cash endowment two weeks after the experiment day and had to use their own money to pay the experimental loss (if any) on the experiment day. We compared the effect of delayed payment on overbidding in the induced value SPAs with the conventional “on-the-spot” payment mechanism when the subjects received an endowment on the experiment day, and the prepaid mechanism when the subjects received the endowment two weeks before the experiment day. Each auction was repeated for 20 rounds to provide sufficient learning opportunities to the bidders. Bids converged to their corresponding induced values as subjects gained experience over repeated auction rounds, implying a possible learning effect and suggesting that “bounded rationality” contributed to overbidding in SPAs. We found that bids were significantly lower with delayed payment of the endowment, compared to the “on-the-spot” payment mechanism. Furthermore, in the presence of liquidity constraints, both delayed and prepaid payments reduced overbidding; while in the absence of liquidity constraints, only the delayed payment reduced overbidding. Our results suggest that a mechanism that makes loss truly costly and provides subjects with sufficient learning experiences may effectively reduce overbidding in laboratory SPAs