TCS Daily


Google's "Winner's Curse"

By James D. Miller - May 4, 2004 12:00 AM

Google intends to auction off around $2.7 billion worth of its stock, but warns potential investors of the winner's curse. This winner's curse should cause participants in Google's IPO stock auction to lower their bids.

To understand the winner's curse, first guess how much money I make teaching economics at Smith College. What would you think if, among all the readers of this article, your guess was the highest? It's certainly possible that everyone else greatly underestimated how much I make. But, most likely, everyone else was not mistaken and you greatly overestimated my salary.

Now imagine that you're bidding on a painting at auction and because you believe the art more valuable than anyone else does, you bid the most and so "win" the piece. As before, it's possible that all others greatly underestimated the art's worth, but chances are the majority knows something you don't.

Winning an auction usually means that you thought the item was worth more than anyone else did. This is bad news because other people probably know something about the good that you don't, so the mere fact of your winning should cause you to lower your estimate of the good's value.

Of course, if you are buying something purely for your own pleasure then the winner's curse doesn't apply, because you then shouldn't care about other' valuations. If, however, you're buying for investment purposes then you must obviously worry about how much other people will someday be willing to pay for the good.

Google intends to sell shares of itself through an auction in which Google stock is sold to those willing to pay the most per share. This means, for example, that if only 20% of the bidders end up with Google stock, these 20% will consist of people who bid the most for Google. Now, if you end up being one of these "lucky" 20% should you worry that the winner's curse has stricken you since you apparently valued the stock at an amount greater than what most investors believed Google to be worth?

Rational investors will take the winner's curse into account when making a bid. For example, assume that before the auction you think a share of Google is worth $100. But you figure that if you end up being a winner in the auction it means that most investors think Google is worth less than $100. So, the act of winning will cause you to think Google is worth only $80 a share. You should, therefore, bid no higher than $80, an amount diminished by the winner's curse.

In its registration statement Google links the dangers of the winner's curse to speculation that its share auction might attract a "lower level of participation by professional long-term investors." What Google is essentially saying is that whereas sophisticated investors understand the winners curse and will factor it into their bid, unsophisticated investors might not. If these naive investors end up dominating Google stock auction then Google shares will initially trade for more than their worth, but when professionals take over the day-to-day trading of Google the stock will quickly fall to its true value, punishing all investors ignorant of the winner's curse.

The following is Google's winner's curse warning from its SEC registration statement:

"The auction process for our public offering may result in a phenomenon known as the 'winner's curse,' and, as a result, investors may experience significant losses.

"The auction process for our initial public offering may result in a phenomenon known as the 'winner's curse.' At the conclusion of the auction, bidders that receive allocations of shares in this offering (successful bidders) may infer that there is little incremental demand for our shares above or equal to the initial public offering price. As a result, successful bidders may conclude that they paid too much for our shares and could seek to immediately sell their shares to limit their losses should our stock price decline. In this situation, other investors that did not submit successful bids may wait for this selling to be completed, resulting in reduced demand for our Class A common stock in the public market and a significant decline in our stock price. Therefore, we caution investors that submitting successful bids and receiving allocations may be followed by a significant decline in the value of their investment in our Class A common stock shortly after our offering.

"To the extent our auction process results in a lower level of participation by professional long-term investors and a higher level of participation by retail investors than is normal for initial public offerings, our stock price may decrease from the initial public offering price and be more volatile."

James D. Miller writes The Game Theorist column for TCS and is the author of Game Theory at Work, which discusses the winner's curse and many other economic phenomena. He recently wrote for TCS asking if Massachusetts should be allowed to outsource jobs.


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