Have you ever won something at an auction and immediately wondered if you paid too much? Maybe you got caught up in the excitement of bidding on eBay, kept clicking that button, and then felt a weird twinge of regret when you actually won? If so, you’ve experienced what economists call the “winner’s curse,” and trust me, you’re not alone. This quirky phenomenon affects everyone from oil companies to NFL team owners, and understanding it might just save you some money and heartache.
The Mystery of the Money Jar
Let’s start with a fun experiment that economists love to run. Picture this: a professor fills a jar with coins and shows it to a classroom full of students. The jar contains exactly $25, but nobody gets to open it or count the money. Students can look at it, shake it around a bit, and make their best guess about how much is inside. Then comes the auction: whoever bids the highest gets the jar and its contents, but has to pay whatever they bid.
Here’s where things get interesting. When researchers run this experiment, something predictable happens every single time. The average guess is usually pretty conservative, often coming in below the actual $25 value. Smart, right? People don’t want to overpay. But then the winning bid comes in at, say, $31. The winner just paid $31 for $25 worth of coins. They “won” the auction, but they actually lost $6 in the process.
Welcome to the winner’s curse!
So What Exactly Is the Winner’s Curse?
The winner’s curse is the tendency for the winning bid in an auction to exceed the true value of whatever is being sold. It sounds contradictory at first. After all, isn’t the winner supposed to be, well, winning? But here’s the catch: in auctions where nobody knows the exact value of what’s being sold, the person who wins is usually the person who overestimated the value the most. They were the most optimistic bidder, which also means they were probably the least accurate.
Think of it this way: if ten people are guessing the value of that coin jar, their estimates will spread out across a range. Some will guess too low, some will be close to accurate, and some will guess too high. The person with the highest guess wins the auction. But being the highest doesn’t mean being right. In fact, it often means being the most wrong in the wrong direction.
The Oil Field Discovery That Started It All
This concept wasn’t dreamed up in an economics classroom. It came from the real world, specifically from oil fields in the Gulf of Mexico. Back in the 1970s, engineers at Atlantic Richfield noticed something puzzling. Their company kept winning auctions for offshore drilling rights, which should have been great news. More drilling rights meant more oil, right?
Not exactly. When they actually drilled for oil, they kept finding less than expected. Their highly skilled geologists had estimated there would be X amount of oil, they bid based on those estimates, they won the auctions, and then reality fell short. One engineer calculated that these companies would have actually earned better returns by putting their money in a credit union instead of winning oil drilling auctions. That’s when they realized the problem wasn’t with their geologists. The problem was with their bidding strategy.
The engineers published their findings, and the term “winner’s curse” was born. It turns out that when you win an auction, you’re not getting a random selection of all the plots you bid on. You’re getting the ones where you bid higher than everyone else, which probably means you were more optimistic than everyone else. And if everyone else thought those plots were worth less, they might have been onto something.
Real World Examples: From Sports to Skyscrapers
Once you know about the winner’s curse, you start seeing it everywhere. It shows up in some pretty surprising places, affecting decisions that involve millions or even billions of dollars.
The NFL Draft Dilemma
Here’s a sports example that Nobel Prize winner Richard Thaler loves to talk about. In the NFL draft, teams take turns picking college players to join their roster. The team with the worst record from the previous season gets the first pick, which sounds like a massive advantage. After all, they get to choose any player they want.
But Thaler and his colleague Cade Massey discovered something fascinating: that first pick is often a curse in disguise. Teams routinely trade away multiple future draft picks and players just to move up and grab that top spot. Then they pay the first pick player an enormous contract. The result? When you factor in the salary costs, the first overall pick is often worth less than the first pick of the second round.
Why? Because teams fall victim to the winner’s curse. They overestimate how good that top player will be, overpay to get him, and then overpay him in salary. Meanwhile, someone like Tom Brady, who was drafted with the 199th pick in the sixth round, goes on to become one of the greatest quarterbacks of all time. The teams that “lost” the race for early picks sometimes end up better off.
Corporate Takeovers Gone Wrong
The winner’s curse also haunts the world of corporate acquisitions. When multiple companies bid to buy another company, the winner is often the company that overestimated the value of the acquisition. Studies have shown that in bidding wars between firms, the companies that lost the bidding war actually outperformed the winning firms by about 24% in subsequent stock market returns. The “losers” dodged a bullet by not overpaying.
Construction Contracts and the Low Bid Problem
Ever wonder why so many public construction projects go over budget? The winner’s curse plays a role here too. When governments put out contracts for construction work, they typically accept the lowest bid. Makes sense, right? Save taxpayer money. But the company that wins with the lowest bid is often the one that underestimated how difficult and expensive the work would be. They either go bankrupt partway through, or they cut corners to stay afloat, or the project ends up costing way more than originally planned. Either way, the “winner” of the contract often ends up cursed.
Why Do We Keep Falling for It?
If the winner’s curse is such a well-known phenomenon, why do smart people keep falling victim to it? The answer lies in how our brains work.
First, there’s the simple fact that we tend to be overconfident. When you’re bidding on something, you’ve done your research, you’ve made your calculations, and you feel pretty good about your estimate. It’s hard to step back and say, “But wait, what if I’m the one who’s overestimating here?”
Second, emotions get involved, especially in competitive situations. When you’re in a bidding war, whether it’s for a house or a company or a painting, your ego gets tied up in winning. You start thinking less about the actual value and more about beating the other bidders. That painting you’re bidding on isn’t just a painting anymore; it’s a symbol of victory. This is sometimes called the “hubris hypothesis” in corporate takeovers. CEOs become so focused on winning the deal that they lose sight of whether the deal is actually worth winning.
Third, there’s the information problem. In these situations, nobody knows the exact value of what’s being sold. If you’re bidding on drilling rights, you don’t know how much oil is really down there. If you’re bidding on a company, you don’t know for sure what their future earnings will be. You’re making educated guesses, and the person who guesses highest gets to find out if they were right. Spoiler alert: they usually weren’t.
The More the Merrier? Not in Auctions!
Here’s a detail that makes the winner’s curse even more interesting: it gets worse as more people join the bidding. If you’re competing against two other bidders, one of you might get lucky and make a reasonable estimate that’s also the highest. But if you’re competing against 20 bidders, the odds that the highest estimate is way off base go up dramatically.
Think of it statistically. With more bidders, you have more opportunities for extreme estimates. Someone in that group is going to be the outlier who thinks the jar has $50 worth of coins when it really has $25. And that someone is going to win the auction and immediately regret it.
How to Avoid the Curse: Strategies for Smarter Bidding
So how do you protect yourself from the winner’s curse? Richard Thaler offers some straightforward advice: before you place a bid, ask yourself, “If I win this auction, will I be happy?”
That simple question forces you to think differently. Winning isn’t the goal. Getting good value is the goal. If you’re going to feel a pit in your stomach when you win, that’s your brain telling you something important.
Here are a few more strategies that can help:
Bid below your estimate. This is called “bid shading” in economics. If you think something is worth $100, bid $80. Why? Because if you win, that means you had the highest estimate, which suggests your estimate might be too high. By bidding below your estimate, you’re giving yourself a cushion for that potential overestimation.
Remember that winning is bad news. This sounds weird, but it’s true. In a common value auction where everyone is guessing at the true value, winning means your guess was the most optimistic. That’s not actually good news about the item’s value. It’s bad news about your estimate.
Do more research than your competitors. If you can find information that other bidders don’t have, or if you can assess value more accurately than they can, then you have an edge. You’re no longer just the most optimistic bidder; you’re the most informed bidder.
Avoid getting emotional. Easier said than done, but try to separate your ego from the bidding process. You’re not trying to win a competition; you’re trying to acquire something at a reasonable price.
Be extra cautious in crowded auctions. The more bidders there are, the more likely it is that the winner is way off base. If you know there are lots of competitors, shade your bid even more aggressively.
Some Smart Moves: Learning from the Winners Who Avoided the Curse
Not everyone falls for the winner’s curse. Some organizations have figured out how to game the system.
Remember those NFL teams? After years of overpaying for top draft picks, some teams got wise. The San Diego Chargers (now the Los Angeles Chargers) are a great example. In 2001, they had the first overall pick, which traditionally would have been seen as a golden ticket. Instead, they traded it away to the Atlanta Falcons for a lower pick plus additional picks in that draft and future drafts. The Falcons used the top pick to select quarterback Michael Vick. The Chargers used their lower picks to select running back LaDainian Tomlinson (who became one of the best running backs of his generation) and quarterback Drew Brees (who went on to win a Super Bowl). By trading away the “curse” of the top pick, the Chargers came out ahead.
Other teams like the New England Patriots and Philadelphia Eagles made similar strategies a core part of their approach. They consistently traded down in the draft, accumulating more picks at lower positions rather than spending everything on high picks. Not coincidentally, these teams dominated the NFL for years.
The Behavioral Economics Revolution
The winner’s curse is just one of many “anomalies” that behavioral economists have discovered, times when real human behavior doesn’t match what traditional economic theory says we should do. Richard Thaler spent decades documenting these anomalies, and in 2017, he won the Nobel Prize in Economics for his work.
Traditional economics assumed people were perfectly rational, always making decisions that maximized their own benefit. Thaler and others in the behavioral economics movement showed that real people are much more interesting and complicated than that. We get overconfident. We care about fairness even when it costs us. We make decisions based on how choices are framed rather than on the underlying value. We struggle with self-control. In other words, we “misbehave” compared to the idealized economic models.
But here’s the thing: these aren’t really misbehaviors. They’re just human behaviors. By understanding them, we can make better decisions and design better systems. That’s the promise of behavioral economics, and it’s why the winner’s curse matters. It’s not just a quirky phenomenon; it’s a window into how we actually think and make choices.
The Takeaway: Think Before You Bid
So the next time you find yourself in a bidding situation, whether it’s at a charity auction, on eBay, or negotiating for a house, remember the winner’s curse. Take a step back. Ask yourself if you’ll really be happy if you win. Consider the possibility that your estimate might be too optimistic, especially if you’re competing against lots of other bidders.
And if you do win? Congratulations! Just maybe do the math one more time to make sure you didn’t pay $31 for that $25 jar of coins.
The winner’s curse teaches us that winning isn’t everything. Sometimes, coming in second place is the real victory. It’s a counterintuitive lesson, but then again, some of the most valuable insights about human behavior are the ones that surprise us. After all, if we were perfectly rational all the time, economics would be a lot less interesting and behavioral economists like Richard Thaler would be out of a job. Luckily for them (and for us), humans are endlessly fascinating in our predictably unpredictable ways.