Off the wall bids’ create a moral hazard problem, the bidders cannot always see the other bidders and so they are unable to monitor the auctioneer. How could the risks inherent in ‘off the wall bids’ be controlled?
It is difficult to control false bids in an open auction. Known as an English auction or an open ascending auction, this is the format used by art dealers. Under this auction’s mechanism, participants bid openly against one another, with each subsequent bid higher than the previous bid. The auctioneer usually announces prices or display the highest current bid in a board. Bidders may call out their bids themselves, or submit bids electronically, or have a proxy call out a bid on their behalf. In some cases, a maximum bid might be left with the auctioneer, who may bid on behalf of the bidder according to the bidder's instructions. The auction ends when no participant is willing to bid further, at which point the highest bidder pays his or her bid. An advantage of this mechanism is that bidders can “learn” about the true value of an item from each other’s bids.
A large area of economic theory has studied the design of auctions and the outcomes of different types of auctions. A general theoretical result shows that open bidding, during an extended period of time, with a large number of bidders, will result in a final bid that is very close to the true market value of the item being sold.
Alternative auction mechanisms can mitigate the effect of ‘off the wall bids’.
- Conduct a sealed first-price auction or first-price sealed-bid auction. Under this auction’s mechanism all bidders simultaneously submit sealed bids so that no bidder knows the bid of any other participant. The highest bidder pays the price he or she submitted. A disadvantage of this auction is that bidders can only submit one bid and cannot adjust their own bids using information from other bidders.
- Conduct a Dutch auction or open descending price auction. Under this auction’s mechanism, the auctioneer begins with a high asking price which is lowered until some participant is willing to accept the auctioneer's price.
- Conduct a Vickrey auction or sealed-bid second-price auction. This auction’s mechanism is the same as the sealed first-price auction, except that the winning bidder pays the second highest bid rather than his or her own. This system is similar to the proxy bidding system used by eBay, where the winner pays the second highest bid plus a percentage bidding increment.
Beyond the above three mechanisms, there are other ways to avoid ‘off the wall bids’, such as having a system of registered bidders, or trusting on the reputation of an ethical auctioneer.
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