This is The Indicator from Planet Money.
I'm Darian Woods, here with Greg Roselski, all the way from Planet Money.
That's right.
Made a long trip all the way from a different planet.
Greg, I held a bit of a behavioral economics experiment the other day.
I'm recording.
I got the whole indicator team together.
Let me go find a writing equipment.
And I auctioned off a jar of coins.
Can you see that?
They look like quarters.
If you're an econ nerd, you might have heard of this game.
It's like a kind of a famous behavioral economics game.
So basically, like you don't tell people how much money is in the jar.
Then people have to place bids and the highest bidder wins the jar of coins.
Yeah, that's right.
And those bids were binding.
The colleague who bid the highest would need to actually pay me.
But, you know, in return, they get that jar of coins.
Okay, I'm going to hand it to Cooper.
He can have a look.
All right.
Give it a good shake.
You can write down your bids.
This is your only opportunity.
There's no more opportunity.
No take back.
I'm so bad at these how many things are in the jar games.
This is my laundry dream.
Okay, three.
Yeah, build some tension.
Two, one, submit.
$5.
$7.75.
$7.75.
Corey Bridges, you are the winner.
$9.25.
Congratulations.
Was it exactly $9.25?
The actual value is $8.
So, Corey.
Oh, man.
You bid $9.25.
You overpaid a little.
I'm sorry.
You know, I won and I lost.
It kind of stings.
It kind of stings.
I'm not going to lie.
So this is called the winner's curse.
Oh, my gosh.
Oh, the winner's curse.
I've definitely felt this myself.
Like I come to think of like using eBay and trying to buy like a vintage snowboard and then be like oh, why did I pay that much for this?
Well, we're going to explain exactly what this curse means.
Today on the show we speak to the Nobel laureate who popularized the term and we ask whether we might see the winner's curse in tech companies race to dominate AI.
Richard Thaler is a professor of economics at the University of Chicago.
He was part of a small group who invented behavioral economics.
This is, you know, the subfield studying how human psychology affects markets.
And I told him about that experiment we'd done.
My colleague, Corey Bridges, bid $9.25 for this jar of $8 worth of coins.
So he overpaid.
Do you have any words for him?
Well, he just discovered the winner's curse.
This is a phenomenon that was not discovered by economists or psychologists, but by oil drillers back in the 70s.
Oil companies were bidding on the rights to drill in areas of the Gulf of Mexico, and one company noticed that the plots that they won tended to have less oil than they expected.
And they're thinking, what's going on?
We have world-class geologists.
We think we know what we're doing.
And what they realized is there wasn't any problem with their geologists.
The problem was with their bidding.
And the big insight they got was...
The auctions you win are not a random sample of the ones you bid.
They're the ones you bid high.
Now, think about it this way.
Suppose there's three bidders and you win.
Well, you should be pretty happy.
If there were 100, you should be pretty worried.
You should be worried because if there are a lot of bids coming in but you're bidding highest, that probably means you're the most optimistic about how much you think the thing is worth.
Yeah, I mean, we all make our best guesses about how much something is worth, and the outlier guesser is the one that wins.
So if I win an auction, basically everyone else thinks I'm wrong.
The wider lesson for business is the more bidders there are, the more cautiously you need to bid.
Richard has applied this in his own work in the private sector.
In 2020, he joined a board of a company that was looking to buy other companies in the sports industry.
And he noticed that a lot of the companies that it was looking to buy also had a lot of other bidders.
And I realized, oops, this is a winner's curse situation.
And so I think my contribution to being on this board was to warn everybody.
Look, we're in danger here.
I propose a rule.
We only talk to companies that give us exclusivity.
So we're the only bidder.
Richard Thaler also found the winner's curse in the NFL draft.
It's also in the world of mergers and acquisitions.
Big corporations are... constantly buying and selling other companies.
One study of 56 company takeovers from the mid 80s until 2012 is really revealing.
The researchers looked at instances where you had multiple companies bidding to buy another company and the company that you know did the merger that put in the highest bid would go on to be significantly less profitable compared to the losing bidders.
I feel like we've just had this wave of corporate breakups recently.
Like, Warner Brothers splitting with Discovery after their big merger.
Yeah, I mean, I could just kind of rattle these off here.
There's the double-barreled Kraft Heinz family.
They're splitting up.
There's, you know, Keurig and Dr. Pepper.
They've separated.
It's been kind of a bumper year for corporate divorce attorneys.
And the winner's curse partly explains why so many corporate mergers go wrong.
But Greg, this kind of left me feeling kind of nihilistic.
So if there's a winner's curse, Why engage in business at all?
Does this not imply that anyone winning a bid for anything is likely to be overpaying?
Should we all just shut up shop?
No, you have to.
It's certainly possible to win a lot of money in an auction.
It helps if you're the only bidder.
That's one way around it.
Look, a friend of mine years ago we're both winos and we were participating in a wine auction once and used the strategy of making lots of very low bids and figured we hardly would win any but the ones that we won.
We wouldn't be cursed.
And then it turned out something was going on in the city where there were some demonstrations and the people were unable to show up for the live auction.
We ended up winning a lot of wine, but at very cheap prices.
Well, congratulations.
Thank you.
Just, I think I may have drank my last bottle from that.
This got us thinking about the AI race happening at the current moment.
Tech companies like Meta and OpenAI are bidding extraordinary amounts of money for top AI talent.
They're also entering into big negotiations for computing capacity.
Could there maybe be like a winner's curse here, where the company that poaches that AI researcher or wins that big contract is actually the one that overestimated what's at stake in the AI race?
Yes, it could be that they have to compete with older technologies.
Google is still pretty good.
Yeah, I use it pretty regularly.
You know, so is Wikipedia.
And if I have to invest a trillion dollars...
To get AI and it's only somewhat better than some other technology.
I may not end up making a lot of money.
So if there is an AI winner, potentially we could see a world where there's a winner's curse with the one that ends up investing the most.
It certainly could be that way.
Richard Thaler says there are many other forces in this complex world, but the winner's curse is something to watch out for.
Well...
I will tell Corey Bridges that he's in fine company with his winner's curse.
And I'll give him a dollar.
I'm sure he'd appreciate that.
He could use his Nobel Prize money.
Yeah, I think he could afford that.
Richard Thaler's new book he co-authored is called The Winner's Curse, Behavioral Economics Anomalies Then and Now.
This episode was produced by Julia Ritchie with engineering by Robert Rodriguez.
It was fact-checked by Sierra Juarez.
Kate Kincannon edits the show and The Indicator is a production of NPR.
