Dutch Auction Explained
Dutch Auction is an auction process where the auctioneer starts with a high asking price and then lowers in it stages until there are enough bids to sell the entire offered quantity. This type of auction is common in initial public offerings to find the optimum price for the full quantity of stocks offered in that round.
A Little More on the Dutch Auction Process
The investors submit their bids stating how many shares they are willing to buy and the price they want to pay for it. After collecting all the bids, the auctioneer assigns the shares to the bidders from the highest bid down until all the shares are assigned. The price paid by each bidder is based on the lowest price of all allotted bidders or the last successful bid. For example, someone bids $100per share for 10,000 shares, and the last successful bid is $90 per share, then he or she needs to pay $90 per share for 10,000 shares.
During bidding the auctioneer starts with a prohibitively high price for the offered securities. For example, he sets it to $100 per share. Then he lowers into $90 per shares and receives two bids for 5,00,000 shares. Then he again lowers the price to $85 per shares and receives bids for 4,000,000 shares. Then he further lowers it to $80 and attracts 5,000,000 shares worth of bids, then the auctioneer lowers the price to $75 and gets another 3,000,000 in bids before the auction closes. Then the auctioneer calculates the highest price at which all shares will be sold. The highest bids adding up to 10 million shares are the winning bids. Then the lowest winning price bid on those 10 million shares (in this case $80) is set as the price of all shares and all the winning bidder pay this price. The ones who offered $90 or $100 will also pay $80 for their share. The bids are compared only after the closing of the auction.
The U.S. Treasury uses this method for auctioning their securities. The bidders bid online through Treasury Direct or Treasury Automated Auction Processing System. The bids are accepted up to 30 days in advance of the auction.
References for Dutch Auction
Academic Research on Dutch Auction
- ● The relative signalling power of Dutch‐auction and fixed‐price self‐tender offers and open‐market share repurchases, Comment, R., & Jarrell, G. A. (1991). The Journal of Finance, 46(4), 1243-1271. This research explores three forms of stocks repurchase, which are the Dutch auctions, the self-tender program, and the open market share program. The objective of this research is to show the various factors responsible for an increase in price of stocks’ buyback values.
- ● Dutch auction repurchases: An analysis of shareholder heterogeneity, Bagwell, L. S. (1992). The Journal of Finance, 47(1), 71-105. This research explores the impact of firm’s involvement in a Dutch auction. Results show that firms with larger trading volumes benefits more from supply elasticity as a result of repurchased shares from Dutch auction.
- ● Auction institutional design: Theory and behavior of simultaneous multiple-unit generalizations of the Dutch and English auctions, McCabe, K. A., Rassenti, S. J., & Smith, V. L. (1990). The American Economic Review, 80(5), 1276-1283 This paper analyses the effect of call market on Dutch and English auctions.
- ● Earnings signals in fixed-price and Dutch auction self-tender offers1, Lie, E., & McConnell, J. J. (1998). Journal of Financial Economics, 49(2), 161-186. This article aims to show how self-tender offers can affect the market signal or debt ratios of firms. Emphasis is placed on 286 self-tender offers between 1980-1997, as case study.
- ● Design of an Internet-based system for remote Dutch auctions, Rockoff, T. E., & Groves, M. (1995). Internet Research, 5(4), 10-16. This article proposes the creation and/or use of technology in Dutch auctions. This app is intended to work in real life, and provide all the features of a normal Dutch auction, like the ability for all bidders to start at the initial price of a stock, amongst numerous others.
- ● Dutch auction versus fixed-price self-tender offers for common stock, Kamma, S., Kanatas, G., & Raymar, S. (1992). Journal of Financial Intermediation, 2(3), 277-307. This research explores the differences between Dutch auction self-tenders and fixed-priced stocks. The objective is to show that shareholders get more returns on retiring greater equities fractions on Dutch than fixed stocks after the cost of equity retirement has been deducted.
- ● Incentives and behavior in English, Dutch and sealed‐bid auctions, Coppinger, V. M., Smith, V. L., & Titus, J. A. (1980). Economic inquiry, 18(1), 1-22. The research explores the difference in the price behaviour of the English and Dutch auction, and the First-price auction and Second-price auction. Results show that the English and Second-price auction are similar and may be isomorphic, while the Dutch and First-Price auction might not be. This experiment is carried out by use of the Vickrey’s Nash postulate.
- ● The success of acquisitions: Evidence from divestitures, Kaplan, S. N., & Weisbach, M. S. (1992). The Journal of Finance, 47(1), 107-138. This research explores the success and failures of diversifying acquisition. The main objective is to defend against the believe that diversifying acquisitions are less successful than their counterparts.
- ● Dutch auction rate preferred stock, Alderson, M. J., Brown, K. C., & Lummer, S. L. (1987). Financial Management, 68-73. This research investigates a recent innovation in corporate finance and cash management, dutch auction rate preferred stock. A sample of 201 dutch auctions were taken for examination. Results show that DARPS issuers provide a higher after-tax return in relations to commercial paper and treasury bills.
- ● Predictable stock returns in the United States and Japan: A study of long‐term capital market integration, Campbell, J. Y., & Hamao, Y. (1992). The Journal of Finance, 47(1), 43-69. This article examines the predictability of monthly excess returns on equity over the domestic short-term interest interest rate of both the US and Japan in 1971-1989. The objective of this research is to show how integration of long-term market capitals help provide more accurate predictions of excess returns of involved parties.
- ● Is the Dutch auction IPO a good idea, Anand, A. I. (2005). Stan. JL Bus. & Fin., 11, 233. This research explores the credibility and effects of a Dutch initial public offering.