Auctions are a form of price discovery in which prospective buyers compete with each other by placing price bids until only one price remains. In auctions for most assets or goods, multiple buyers bid the price up, but for some large-issue securities like U.S. Treasuries and some stock IPOs, auctions discover the lowest possible price for every security available.
Auctions for single investment assets like a piece of property or artwork as well as consumer-oriented auction websites like eBay are conducted as regular ascending price auctions, where each bid places a higher bid than the previous until only one remains. In some cities (like Sydney, Australia) with an undersupply of developed property, all real estate sales are conducted by such auctions.
A growing number of asset sales are being conducted using a descending-price auction, also called a Dutch auction because it was first used in tulip-bulb auctions in 17th-century Netherlands. Dutch auctions involve issuers revealing how much of a security they want to sell and sometimes a possible price. Prospective buyers then place secret bids for the quantity and price they want to purchase and afterwards are allocated amounts based on whether their bids met the issuer's minimum set price.
The most familiar Dutch auctions for investors are the ones used by the U.S. Treasury to sell Treasury bills, Treasury notes and Treasury bonds as well as Treasury Inflation Protected Securities (TIPS). In competitive-bidding Treasury auctions each bidder specifies the yield s/he is seeking and can bid for up to 35% of the issue. In non-competitive bidding the bidder can buy up to $5 million worth of the issue and must accept the yield of the highest price bidder. The Treasury accepts competitive bids in ascending order by yield until all the issue is sold.
Dutch auctions for share initial public offerings (IPOs) were pioneered by San Francisco-based brokerage WR Hambrecht, which claims to have democratized the IPO process compared to the established process of underwriter allocation. The same Dutch auction process was used by internet search-engine powerhouse Google.com in its $2.7 billion IPO in 2004, where the bidding and price discovery were both fully automated. These kinds of auctions were first proposed by Nobel prize-winning economist William Vickrey.
- ↑ Dutch auction Definition. InvestorWords.com.
- ↑ How Treasury Auctions Work. Treasury Direct.
- ↑ OpenIPO: How It Works. WR Hambrecht.
- ↑ IPO Dutch Auctions Vs. Traditional Allocation. Forbes.