The Winner’s Curse

In any bidding process, whether an open outcry auction, M&A offerings or any other process were investors compete for a scarce asset under a defined timeline, there will inevitably be a winner.

That winner will be the one who was willing to part with the most cash in order to gain possession of the asset being sold.

Information Asymmetry

What any victor in an auction process should ask himself is “why did I end up bidding the highest price?”

There can be many good reasons for paying the highest price:

  • Structural advantages: if you can leverage the assets, for example by adding it to your distribution network, the asset might have more value in your hands than with other bidders.
  • Elimination of competition: if the asset is a direct competitor to an existing business, it could have more utility to you than other bidders.
  • Informational advantages: you simply might know more about the asset than other bidders

The last point is the key to the Winner’s Curse. If it is you that knows less about the asset than the competing bidders, then by winning the auction, you will likely have overpaid.