- What do tulips, crypto tokens and Google shares all have in common?
- Tulip mania may have disappeared, but Dutch auctions have not
Dutch auctions, fittingly enough, take their name from the method used to price bulbs in the wake of ‘tulip mania’. In contrast to a regular auction, prices start high and drop until a buyer jumps in with a bid. As soon as they do, the auction stops. There are no counter bids, no ‘going…going…gone’ – the first bidder takes the lot. Dutch auctions are fast. As such, they work well for perishable goods such as food and flowers; auctions end at lightning speed meaning sellers can control how quickly the stock is sold.
But this isn’t the whole story: after all, tulip mania didn’t involve trade in cut flowers. Instead, bulbs of rare and sought-after varieties were auctioned in a kind of early futures market. At the peak of the mania, a single bulb could fetch the price of an Amsterdam townhouse, but within a year the market collapsed. The sorry episode now represents one of the most famous economic bubbles of all time. But although tulip mania may have disappeared, Dutch auctions have not.
US Treasury auctions use a Dutch auction mechanism, where successful buyers pay the same (lowest successful) price. They can also be found at the riskier end of the investment spectrum, finding a new lease of life in the crypto sphere through initial coin offerings (ICOs). Following Solana’s ICO in 2022, crypto token sales management platform CoinList praised Dutch auctions as “a fair and effective launch mechanism for projects because every participant buys tokens at the same price and all participants collectively determine that price”.
They are also used in the art world. Recently, Chicago-based A Very Serious Gallery ran a Dutch auction for art by graffiti artist Penny Pinch. Despite being told by peers that the move would be “pricing suicide”, the gallery persisted: prices were set high and reduced by $100 an hour until the work sold. The average sale price soared, and the gallery told the IC that “the Dutch auction format absolutely contributed to higher prices — patrons knew it and absolutely loved it”.
The rumble created by Dutch auctions is often part of their attraction. Take (what was then) Google: its unorthodox 2004 IPO used a Dutch auction sale. Eric Schmidt, one-time chief executive and executive chairman of Google, later reflected on fears that Google would lose its innovative spirit as it transitioned from a start-up to a public company. He argued in 2010 that “one of the reasons we have held on to our values is that we chose an unconventional path to going public”.
In a traditional IPO, an investment bank takes the issue on a ‘roadshow’ to possible investors to determine the price for the IPO. This means that in general, only institutional and sophisticated investors are involved. A Dutch auction model, on the other hand, lets small investors participate by posting the price they are willing to pay and the number of shares they want to purchase (as low as five in this case). Schmidt said that “we wanted something much more transparent and open – and we wanted our users to have a chance to take part”.
But the issue was not without issues. Advocates of Dutch auction IPOs argue that by minimising the role of investment banks, the process is democratised. But economist Nayantara Hensel questioned whether they really provide an efficient pricing mechanism: Google debuted at $85 a share, significantly less than the initial estimate range of $108-$135. The price later surged, topping $210 by August the following year. According to Hensel, it could be that small investors lack access to enough information to appropriately price the security “based on fundamentals, rather than on name recognition”.
The mechanics of Dutch auctions also mean that bidders lack another piece of information – the value of the second-highest bid. This has surprising implications for buyer satisfaction. Prevailing wisdom suggests that in a traditional auction, knowing the difference between the winning and second-highest bid could cause ‘winners’ regret’. Is this absent in a Dutch auction? A 2019 paper found that the opposite was the case: the missing disclosure of a second-highest bid actually caused more winner regret than a traditional auction does.
