A Laboratory Test of Auctions with Negative Externalities

We employ a laboratory experiment to analyze an auction model with interdependent demand in which competing firms bid for licenses to a cost-reducing technology. Since winning bidders reduce the profits of losers, bids must account for both the value of winning the auction and the negative value of losing brought about by rivals reducing their costs. Experimental treatments differ in the severity of the interdependency (based on the substitutability of competitors' products), and the number of licenses being auctioned. We find that subjects underbid relative to theoretical benchmarks for auctions of one license, but overbid when two licenses are auctioned. This leads to some differences between the distributions of experimental and predicted revenues. We suggest that such differences occur because bidders use a simple heuristic to determine their bids.