Investment Incentives in Auctions: An Experiment

We experimentally analyze first- and second-price procurement auctions where one bidder can achieve a comparative cost advantage by investment prior to the auction. Theory predicts that bidders invest more often prior to second-price auctions than prior to first-price auctions, which is clearly confirmed by our experimental data. Bidding in the auction (after investment) is more aggressive than the equilibrium prediction in both auction formats. Introduction Different market institutions provide different incentives for firms to engage in activities that affect their competitive positions. For example, prior to a procurement auction investments can be made either to reduce a firm’s own cost of production, or even to raise the cost of possible competitors. Empirical evidence indicates that companies make use of this possibility extensively.¹Thus, both auction rules and investment incentives have to be accounted for when it comes to comparing revenue and efficiency of selling (or buying) institutions. A number of papers theoretically analyze investment incentives in procurement auctions. Most of them assume that investment decisions are not observable prior to a competition.²Then, a typical finding is that investment is symmetric so that revenue equivalence between market institutions is preserved also in a model that allows for investment. This is not necessarily true if investment is observable. If firms strategically react to the decisions made at the investment stage, it is not immediately clear whether ex ante symmetry implies symmetric investment.