USING AUCTIONS TO RAISE MONEY FOR CHARITY: SIMPLICITY AND FAIRNESS PAY DIVIDENDS

Charities need to design fundraising auctions very carefully to maximise the number of bidders and therefore the money raised, according to new experimental research by Professor Jeffrey Carpenter and colleagues, published in the January 2008 issue of The Economic Journal.

Professor Carpenter comments:

‘Our study cautions charities to consider carefully their expected participation rates when selecting auction format. Mechanisms that are both easy to understand and perceived as fair will elicit greater participation and thus generate higher revenues. In this regard, “winner pays” auctions may be safer bets than “all pay” formats.’

Charity auctions have increased in popularity in recent years. Among the most high profile successes have been internet sites like eBay’s Giving Works, which has raised $40 million to date.

Economic theory predicts that certain types of auction should raise more than others. In particular, ‘ all pay’ auctions, in which everyone pays what they bid should raise more than standard ‘winner pays ’ auctions. As the latter is common while the former is scarce, the researchers examine whether charities are missing out on an opportunity.

The authors conducted a field experiment at four nursery schools to compare different (sealed bid) auction mechanisms. Analysing the results of 80 auctions, they find that ‘first price’ auctions (in which the winner pays what they bid) generates an average of 45% more revenue than ‘second price’ auctions (in which the winner pays the second highest bid) and 42% more than ‘all pay’ auctions (where everyone pays their bid, but the winner is the highest bidder).

First price auctions are clear and transparent, and are in general perceived as ‘fair’. But they give rise to a perverse incentive: increasing your bid may increase your chance of winning, but it lowers the benefit to you regardless of whether you win or not. Bidders therefore have an incentive to underbid for an item relative to its true value to them.

Second price auctions try to alleviate this problem. All that happens when you reduce your bid is that you reduce the chances that you win: the amount you pay is not determined by what you bid. As a result, people should bid as much as they are willing to pay for an item. This should be good for a charity, but only if the bidders understand this and think it is fair. Otherwise, as the study finds, this sort of clever rule change just confuses potential bidders and makes people shy away from participating.

The all pay auction is similar to raffles: the only difference between the two mechanisms is that the person who spends the most on raffle tickets is only the most likely winner instead of the certain winner. This mechanism should raise more money for the charity as all bidders pay their bid. While each bidder should bid less (there is the chance that one could bid and get nothing), exactly how much less is not obvious.

The research indicates that many people view the all pay auction as unfair, yet many of these same people find raffles fair.

The researchers use the participant bids and the demographics of the non-participants to estimate the revenues that would have been obtained if everyone had entered into each auction. They find that:

• The first price auction would generate an average of $65 per item, the second price auction would generate an average of $46, and the all pay auction would generate an average of $228.


• So if there was full participation, the all pay auction would have the highest revenues, and the second price auction would have the lowest revenues, which is much closer to theoretical predictions.


• The difference between the actual revenue and the full-participation estimates revenue is due to the cost of reduced participation. The total cost is negligible in the first price auction ($92) and the second price auction ($99) but it is substantial in the all pay auctions ($3,796).

ENDS

Notes for editors: ‘Charity Auctions: A Field Experiment’ by Jeffrey Carpenter, Jessica Holmes and Peter Hans Matthews is published in the January 2008 issue of The Economic Journal.

The authors are at Middlebury College.

For further information: contact Jeffrey Carpenter on +1 802 443 3241 (email: jpc@middlebury.edu); Jessica Holmes on +1 802 443 3439 (email: jholmes@middlebury.edu); Peter Hans Matthews on +1 802 443 5591 (email: pmatthew@middlebury.edu); or Romesh Vaitilingam on 07768 661095 (email: romesh@compuserve.com).