5 ONLINE AUCTIONS AND AUCTIONS IN PRACTICE
5.2 Auction Rules
When organizing a real auction, choosing the mechanism and designing the details is not enough; some fine tuning is required. The need for more detailed rules is especially pronounced in electronic auctions, because it becomes more difficult to observe and control bidder behavior and prevent cheating. In this section, I will discuss
rules, which concern issues and behavior that are ignored in theoretical models (e.g.
defaulting on bids, cheating and collusion), but which are important in practical applications. There has been a lot of discussion on auction rules in the context of the FCC Auction #31 (FCC, 2000, Pekeč and Rothkopf, 2000, Vohra and Weber, 2000), which ironically after all the planning and discussions never took place. Also articles by Pekeč and Rothkopf (2003), Kelly and Steinberg (2000) discuss different auction rules, and Klemperer (2002) describes several real auctions where design flaws have led to undesirable auction outcomes.
The reasoning behind rule design is that bidders will try to take advantage of the auction design in any way they can think of. For instance, in iterative auctions with a predetermined ending time bidders may want to wait until the last minute before making a bid. This type of behavior is known as sniping. Snipers hope to be able to surprise the competition with a last minute bid and leave no time for the competitors to respond (Roth and Ockenfels, 2002). If they are successful, the revenue from the auction remains low. To combat this kind of behavior, activity rules have been introduced in iterative auctions which involve substantial amounts of money. Activity rules state how often and what kind of bids a bidder must enter in order to be allowed to continue bidding. Activity rules are often linked to minimum bid increments.
Closing rules affect activity rules. Activity rules become more important, if the auction has a predetermined closing time. However, if the auction closes only after a certain period of inactivity, activity rules are not as critical, but it does not mean they would be unimportant. In an extreme case there would be no bidding activity until right before the closing time. There would still be competition as the ending would be pushed back, but the process of price discovery would not be as efficient undermining one of he benefits of iterative mechanisms. Auction owners may want to use eligibility rules as well. Eligibility rules require the bidders to prove their solvency prior to entering the auction. For instance, they might have to make a deposit, and the size of the deposit determines the size of bids they are allowed to place.
Collusion in the form of collusion rings agreed upon prior to the auction was discussed already in section 2.4. Collusion does not have to be explicit, though. During the auction bidders can try to signal their intentions to competitors. Maasland and
Onderstal (2006) and Klemperer (2002) report a case of signaling in the German GSM auction. In 1999, the German government put 10 licenses up for auction, and required a 10% bid increment. One of the competing firms, Mannesmann, made a bid of 20 million DM on five licenses, and a bid of 18,8 million DM on the other five licenses.
Mannesmann’s main competitor T-Mobile was able to calculate that topping the current high bid of 18,8 million with the required bid increment of 10% would bring the price of these licenses to about 20 million as well. Actually, this was Mannesmann’s way of signaling to T-Mobile its willingness to share the licenses equally; it did not necessarily have to bid for the other five licenses at all. T-Mobile understood the signal, and the auction ended very shortly with the bidders sharing the licenses at the price of 20 million DM. The efficiency of the outcome is hard to determine, but clearly the final price obtained by the seller (German government) was artificially low. This example shows that no explicit collusion among the bidders is necessarily needed for them to reach a silent agreement to not drive up the prices.
In some auctions bidders have used the lower digits of bid prices to signal the items they are interested in (Kelly and Steinberg, 2000). To combat this, the auction owner can require that bid prices follow certain increments. Of course, sealed-bid auctions do not suffer from this type of signaling. Another form of signaling is called jump bidding, which was observed in earlier FCC auctions (McAfee and McMillan, 1996). Jump bidding refers to aggressive bidding behavior, where a bidder places a bid way above the required increment in order to warn other bidders. One way to prevent jump bidding is to use a clock auction, in which the bidders simply announce their demand at the price indicated by the auction clock instead of calling out their own prices (Banks et al., 2003).
Cheating and fraud are also a concern in auctions, and especially in online auctions. It is easier for bidders to remain anonymous, and thereby use multiple bidder identities in the same auction (Pinker et al., 2003, Yokoo et al., 2004). In a similar vein, it is also possible for the bid taker to place bids under a false identity in order to force the auction to a more favorable outcome. These cases of cheating were discussed already in the context of the VCG mechanism in section 3.2.3.1. Bidders could also choose not to pay, or sellers refuse to provide the product after receiving a payment. Auction
designers have tried to design mechanisms to detect and prevent fraud. Also reputation of both buyers and sellers has become a factor in the electronic market places.
Pekeč and Rothkopf (2003) point out that auction rules should also define how ties are to be broken. Theoretically ties are not interesting, because with continuous distributions their probability is zero. In practice, however, it is quite possible that a tie arises, because bidders tend to round prices, or the auctioneer requires bidding at certain bid increments (decrements). In combinatorial auctions it is even more likely because ties can occur in different ways, because the same total revenue can result from many different combinations. In the name of fairness, the ties should be broken based on predetermined rules. One way to break ties is to pick the winning combination randomly. A more sophisticated way is to use time stamps. Each incoming bid receives a time stamp when it enters the auction. The winning combination is then either the one that was completed first (highest time stamp value is lower than the highest stamp value of other combinations), or the one with the lowest average time stamp. Using the time stamps may not be entirely fair though, because due to differences in traffic loads on the Internet, some bids might be at a disadvantage.
Additional issues to be decided on are how to deal with bid withdrawals or defaulting on winning bids. Withdrawals are usually allowed in simultaneous and sequential auctions to alleviate the exposure problem. However, in combinatorial auctions exposure problem is not as crucial, so allowing withdrawals may only make collusion or signaling easier. Penalizing withdrawals and defaulting on winning bids can thus help reduce cheating and “gaming” behavior. Setting eligibility rules and requiring the bidders to make a deposit also ensures that the bidders are capable of paying the penalties.
The important thing to keep in mind in auction design is that each auction is unique and therefore requires a unique combination of design parameters. This fact is emphasized by Binmore and Klemperer (2002), who report their experiences on telecom license auctions in the UK and other European countries. According to them it is not enough that the items for sale are identical to justify using an identical auction
design, because market conditions (number of potential participants, attractiveness of market) vary. Sometimes it is enough to adjust minor rules, but in some cases the whole auction mechanisms needs to be modified. In Binmore and Klemperer’s study, what worked well in the British telecom auctions, did not work in the Netherlands or Switzerland, which clearly demonstrated that auction design should not be copied.