Who Pays When Auction Rules are Bent?

Abstract

In many negotiations, rules are soft in the sense that the seller and/or buyers may break them at some cost. When buyers have private values, we show that the cost of such 'rule bending' is borne entirely by the seller in equilibrium. Consequently, the seller is willing to pay an intermediary to credibly commit to a mechanism in which no one has the ability or the incentive to cheat. Examples of costly rule bending considered here include hiring shill (fake) bidders and trying to learn others' bids before making one's own. Buyers may also invest in legitimate bidding software that can give them an advantage over buyers who enter bids manually and thus are slow to respond to changes in other's bids. In equilibrium, the cost of all such socially wasteful investments (whether made by the buyers or the seller) is passed through to the seller in the form of lower revenues.

Keywords: Auction Rules