When the auctioneer’s hammer finally comes down after a fierce bidding war, the winner cheers. Yet a few days later, after calmly running the numbers, many winners realize they paid far more than the item was worth. This phenomenon, in which the very fact of winning a competition is a sign of loss, is the winner’s curse.
Put simply, the winner’s curse is what happens when people compete for something whose value nobody knows precisely: the person who most overestimates its value wins and ends up paying too much. It is not that the winner was unlucky. It happens because the structure of the competition selects the most optimistic person as the winner.
In this piece we will look in turn at how the winner’s curse first became known and how it works, the coin-jar experiment and real-world cases, and finally smart bidding strategies for avoiding the curse.
How Losing Begins the Moment You Win
What Is the Winner’s Curse?
The term winner’s curse became widely known through a paper that Edward Capen, Robert Clapp and William Campbell, engineers at the American oil company Atlantic Richfield, published in a petroleum engineering journal in 1971. They noticed that in auctions for offshore drilling rights on the continental shelf of the Gulf of Mexico, oil companies earned lower returns than expected year after year.
The value of oil buried underground is almost the same no matter which company takes it. At the time, however, there was no way to know the size of a reserve precisely, so each company’s estimate differed widely. If one company guesses that a field actually worth 10 million dollars is worth 5 million and another guesses 20 million, the lease goes to the company that inflated its estimate the most.
- Winner’s Curse: the phenomenon in which the winner of a competitive bid pays more than the actual value or gains less than expected.
- Common Value Auction: an auction in which the actual value of the item is the same for every bidder, but no one knows that value precisely.
- Private Value Auction: an auction in which value depends on personal taste; in this case the winner’s curse does not arise.
Why the Winner’s Curse Happens
Even if bidders’ estimates are accurate on average, the highest of them is likely to be higher than the actual value. Winning simply means that you were the most optimistic.
(1) It grows with uncertainty
The harder a value is to gauge, the more widely estimates spread out, and the further the highest estimate drifts from the actual value.
(2) It grows with the number of competitors
As the number of bidders rises, so does the chance that someone greatly inflates the value. The hotter the competition, the deeper the winner’s loss.
(3) Victory becomes bad news
Economists explain this point as the “expected value conditional on winning.” If you won, it means everyone else valued the item lower than you did, so you should revise your estimate down accordingly. For example, if ten people bid on the same used item and you win, the other nine all put a lower price on it than you did.
The Winner’s Curse Through Easy Examples
The winner’s curse has been confirmed both in the laboratory and in the real world.
(1) The coin-jar auction experiment
In 1983, Max Bazerman and William Samuelson auctioned jars containing coins and other items to business school students. Each jar was actually worth 8 dollars, and the students’ estimates averaged only 5.13 dollars, lower than the real value. Yet across 48 auctions the winning bid averaged 10.01 dollars, so winners lost an average of 2.01 dollars. Although the group as a whole undervalued the jar, once bidding began the person who valued it highest won and lost money.
(2) Spectrum auctions and corporate takeovers
Around 2000, in third-generation (3G) mobile spectrum auctions in several European countries, telecom companies bid astronomical sums and then struggled with debt for years, a case often cited as a classic example. The same structure appears in takeover battles, where companies pay dearly to acquire another firm.
(3) Free agency in professional sports
When several teams compete for one player, the team that predicts the highest performance wins the contract. When the player later fails to live up to expectations, debates about an “inflated price tag” can follow. A situation in which many would-be buyers flock to one house and keep bidding up the price carries a similar risk.
Smart Strategies for Avoiding the Winner’s Curse
The winner’s curse is not an inescapable fate. Experienced bidders build into their calculations in advance the fact that “if I win, I was probably the one who valued it highest,” and bid less than their initial estimate. This is called bid shading.
- Bid Shading: a strategy of bidding below your initial estimate to account for the overestimation implied by winning.
- Walk-away Price: the habit of deciding, before the auction begins, on a price you will not go above.
The more competitors there are and the more uncertain the value, the more you should shade your bid. It is also important to stick to the limit you set in advance, so that in the heat of the auction room “winning” itself does not become the goal. As economist Richard Thaler noted when he presented this phenomenon as an “anomaly” of economics in a 1988 article, real people do not always lower their bids appropriately the way theory says they should.
The winner’s curse is the phenomenon in which, when people compete for something of uncertain value, the most optimistic person wins and pays too much. The greater the uncertainty and the number of competitors, the deeper the curse, and the remedy is to treat winning as bad news and lower your bid in advance.
Looking first at the limits of your own valuation rather than at the heat of the competition: that is the first step toward a smart choice that lets you win and still come out smiling.
