Dutch auction

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Dutch auction is a type of auction where the auctioneer begins with a high asking price which is lowered until some participant is willing to accept the auctioneer's price, or a predetermined reserve price (the seller's minimum acceptable price) is reached. The winning participant pays the last announced price.

This type of auction is convenient when it is important to auction goods quickly, since a sale never requires more than one bid. Theoretically, the bidding strategy and results of this auction are equivalent to those in a Sealed first-price auction; however, experiment indicates that a Dutch auction typically results in lower sale prices [1].

The Dutch auction is named for its best known example, the Dutch tulip auctions; in the Netherlands this type of auction is actually known as a "Chinese auction" ^{[citation needed]}.

"Dutch auction" is also sometimes used to describe online auctions where several identical goods are sold simultaneously to an equal number of high bidders. Economists call the latter auction a multi-unit English ascending auction.

1 Public offerings
2 Dutch auction share repurchases
3 Dutch Auctions and First Degree Price Discrimination
4 Notes

[edit] Public offerings

The United States Department of the Treasury, through the Federal Reserve Bank of New York (FRBNY), raises funds for the U.S. Government using a Dutch auction. The FRBNY interacts with primary dealers, including large banks and broker-dealers who submit bids on behalf of themselves and their clients using the Trading Room Automated Processing System ("TRAPS"), and are generally told of winning bids within fifteen minutes.

For example, suppose the debt managers are seeking to raise $10 billion in ten-year notes with a 5.125% coupon, and in aggregate the bids are as follows:

$1.0 billion at 5.115%
$2.5 billion at 5.120%
$3.5 billion at 5.125%
$4.5 billion at 5.130%
$3.75 billion at 5.135%
$2.75 billion at 5.140%
$1.50 billion at 5.145%

In this example, the bid-to-cover ratio is 1.95, therefore, not every bidder receive bonds. Bids will be filled from the lowest yield (highest price) until the entire $10 billion has been raised. This auction will clear at a yield of 5.130 percent and all bidders will pay the same amount. In theory, this feature of the Dutch auction format leads to more aggressive bidding as those who in this case bid 5.115% will receive the bonds at the higher yield (lower price) of 5.130%.

A variation on the Dutch auction was used on the IPO for Google stock.

[edit] Dutch auction share repurchases

The introduction of the Dutch auction share repurchase in 1981 allows firms an alternative to the fixed price tender offer when executing a tender offer share repurchase. The first firm to utilize the Dutch auction was Todd Shipyards. A Dutch auction offer specifies a price range within which the shares will ultimately be purchased. Shareholders are invited to tender their stock, if they desire, at any price within the stated range. The firm then compiles these responses, creating a supply curve for the stock.<ref>To understand the Dutch auction bidding and outcome from actual shareholder tendering responses, see Bagwell, Laurie Simon, "Dutch Auction Repurchases: An Analysis of Shareholder Heterogeneity,"1992. Journal of Finance, Vol. 47, No. 1, 71-105.</ref> The purchase price is the lowest price that allows the firm to buy the number of shares sought in the offer, and the firm pays that price to all investors who tendered at or below that price. If the number of shares tendered exceeds the number sought, then the company purchases less than all shares tendered at or below the purchase price on a pro rata basis to all who tendered at or below the purchase price. If too few shares are tendered, then the firm either cancels the offer (provided it had been made conditional on a minimum acceptance), or it buys back all tendered shares at the maximum price.

[edit] Dutch Auctions and First Degree Price Discrimination

In Economics price discrimination is when firms charge different prices to different customers for the exact same good or service. First degree or perfect price discrimination occurs when a firm knows exact details about the demand for its product, therefore meaning they can sell each unit of its output at the maximum price that each individual consumer is willing to pay. This is very rare in real life however a Dutch auction is one of the few examples. This is because the person who wins in a Dutch auction pays the highest price that any consumer is willing to pay. The seller in the auction has therefore extracted all of the auction winners consumer surplus. This is presuming all the competitors in the auction have not colluded.