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Dutch Auction Definition & Explanation
A Simple Dutch Auction is an auction process where the auctioneer or seller starts with a high asking price and then lowers it incrementally or in stages until there is a bid for the item (or batch being sold). At this point, the auction ends and the item is sold.
When there is more than one identical item being sold separately or not as a lot. Bidders will publicly indicate the amount they are will to pay for any item (and the number of items they will purchase at that price). If there are insufficient bids to sell all of the items, the price is lowered further. The auction ends when there are enough bids (or purchasers at a given price) to sell the entire quantity offered for sale. If, at a given price, there are more bids than there are items available, priority is generally given to those who enter their bids first. Everyone pays the same price for the items purchased. This method generally used when setting the price for shares being sold in an initial public offering, for shareholder-initiated tender offers, and sale of US Treasuries.
- Note: There are variations of the Dutch Auction which incorrectly employ the name “Dutch Auction”. A common type of auction confused with the Dutch auction is the Second-Price, Sealed-Bid Auction, also known as the Vickrey Auction.
Example of a Dutch Auction
Let’s assume there are 10 shares of stock for sale. A bidder offers $10 per share of stock for 8 shares. The next highest bidder offers $9 per share for 10 shares. The auction will end, as there are adequate bids to sell all shares. The price paid for all shares will be the lowest successful bid of $9. The first bidder will receive 8 shares at a price of $9 (lower than her original $10 bid). The second bidder will receive the 2 remaining shares (less than her desired lot of 10 shares) at $9.
Academic Research on Dutch Auctions
- 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.
- 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.
- 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.