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Choiceology: Season 5 Episode 5

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Suppose you just won a hotly contested auction. How likely is it that you got a good deal?

Have you ever bid in a competitive auction—say, on eBay—and won the item, only to see a similar item for sale elsewhere at a lower price? If so, you may have fallen prey to the winner’s curse.

In this episode of Choiceology with Katy Milkman, we look at bias that can lead people to overpay in auctions and other types of negotiations.

We begin with the story of Havre de Grace. This prize filly had an exceptionally successful career as a racehorse before being auctioned as a broodmare. Expectations were high for the sale because Havre de Grace had such a strong thoroughbred pedigree. But the way the auction proceeded surprised everyone in the room.

Glenye Cain Oakford was at the Fasig-Tipton November Mixed Sale and paints a vivid picture of a dramatic bidding process. She is an award-winning journalist, writer, and videographer based in Lexington, Kentucky. She was the senior bloodstock correspondent at the Daily Racing Form at the time of the auction

Special thanks to Fasig-Tipton for use of the audio clips from the Havre de Grace auction.

Max Bazerman has contributed important research to the study of the winner’s curse. He joins Katy to discuss the ways in which this phenomenon can affect purchasing decisions around everything from jewelry to oil leases—and how the bias can diminish your ability to negotiate successfully.

Max Bazerman is the Jesse Isidor Straus Professor of Business at the Harvard Business School and the Harvard Kennedy School and the author of many books, including the upcoming book Better, Not Perfect: The Realist’s Guide to Maximum Sustainable Goodness, which will be released later this year by Harper Collins.

Choiceology is an original podcast from Charles Schwab

If you enjoy the show, please leave a rating or review on Apple Podcasts.

Click to show the transcript

ANDY: So I have in front of me a fairly large jar of coins. There’s quarters and nickels and dimes and a few pennies in there. They’ve been counted, but the value of the coins won’t be revealed until after the auction. So have a look at the jar and take a guess at what you think the coins are worth. Don’t tell anyone. Let’s say we start the bidding at $10. Do I hear $10 for this very heavy jar of coins?

CHRIS: $10, $10.

ANDY: $10 to Chris. Do I hear $15?

ALLY: $15.

ANDY: Ally’s got $15. Do I hear $18? $18.

DAVID: $18.

ANDY: $18 from David.

CHRIS: $19, $19.

ANDY: $19 to Chris.

MEL: $20.

ANDY: $20 From Mel.

TARA: $21.

ANDY: $21 from Tara.

CHRISTIAN: $39.

ANDY: $39 from Christian going once, going twice.

MEL: $40! $40.

ANDY: $40 from Mel, going once, going twice, sold to Mel. $40 for this jar of coins, which is worth … $20.

MEL: Aw, man.

CHRIS: Boo.

ANDY: $40 for a jar of coins worth $20. So how do you feel about your win, Mel?

MEL: I’m feeling a little embarrassed. Can I pay you later?

ANDY: Of course. I take check or cash or credit or Venmo or PayPal.

KATY MILKMAN: This very informal auction is based on an experiment that Professor Max Bazerman often runs with his students. It reveals a common pattern that arises when people are competing for something of an uncertain value, and while losing $20 in a play auction is no big deal, this pattern can have expensive implications when it comes to bidding on higher-stakes items, like oil fields.

SPEAKER 9: It was a highly volatile day for U.S. crude prices.

KATY MILKMAN: Engaging in mergers and acquisitions.

SPEAKER 10: And will both Kmart and Sears brands survive in the long run?

KATY MILKMAN: And making investments in the world of thoroughbred horse racing. I’m Dr. Katy Milkman, and this is Choiceology, an original podcast from Charles Schwab. It’s a show about the psychology and economics behind our decisions. We bring you true stories involving high-stakes choices, and then we explore the latest research in behavioral science to help you make better judgements and avoid costly mistakes.

GLENY CAIN OAKFORD: My name is Glenye Cain Oakford.

KATY MILKMAN: Glenye is a journalist, writer, and videographer based in Lexington, Kentucky, and at the time of a legendary horse auction, she was the senior bloodstock correspondent at the Daily Racing Form.

GLENY CAIN OAKFORD: A high-profile horse auction is a very exciting atmosphere, and the auctioneer’s want people to be excited, but there’s also a layer of formality that is also there, especially at the Fasig-Tipton November Selected Mix Sale.

KATY MILKMAN: This particular auction takes place each November in Lexington. The auction includes foals, stallions, and breeding mares—also known as broodmares—and the bidding takes place in the evening.

GLENY CAIN OAKFORD: That’s one of the things that made this auction a little bit special. There are only a few auctions anymore that take place in night-time sessions, and again that adds sort of a layer of excitement and formality to the proceedings. It really is sort of awe-inspiring when you walk into where the actual bidding takes place, where the auction ring is, where the horses stand. The horses glisten under the lights. The auctioneer is in a tuxedo. The bid spotters are in a tuxedo.

KATY MILKMAN: The horses are on the sale grounds for a few days before the auction. So prospective buyers or their bidding agents can inspect the animals.

GLENY CAIN OAKFORD: The barn areas are pretty. They’re decorated with flowers. In the fall, at a sale like this one, often sellers will have tables out front where they’re serving coffee or maybe Bloody Marys or soup. So there’s a lot of a feeling of hospitality at an auction like this, but it’s also extremely busy and studious as the buyers and their people are coming through looking at horses, and at the same time, while they’re doing that, they’re trying not to tip off the competition as to exactly what they’re interested in because they don’t want to generate more competition for themselves when a horse goes into an auction ring.

KATY MILKMAN: Once the auction opens, people gather in a large pavilion.

GLENY CAIN OAKFORD: There’s a sort of semicircular room where the seats are, where the bidding actually takes place. The horses are led into a semicircular auction ring, which is filled with shavings. Again, they’re kind of in the spotlight, and the auction itself is a feast for the senses. The horses are standing under lights. They’re groomed to an amazing shine. They look tremendous. They glitter. There are a lot of people with a lot of money who have been looking at these horses and are sprinkled around from the various places where they prefer to bid. They may have an agent who is on the phone, who is actually in the seats, while they themselves are bidding from somewhere offsite or from an office onsite where they can’t actually be seen, so there’s a lot of strategy involved as well. The auctioneer himself, I once heard him described as having an auction patter that was like a banjo, and in fact that’s quite right.

AUCTIONEER: [auction chant] Auction’s on … turn it up a little bit, Jerry … one down … $5 million on her …

KATY MILKMAN: While there were several animals on auction at this event, we’re most interested in a mare called Havre de Grace. Havre de Grace is a thoroughbred racehorse who was American Horse of the Year in 2011. She was named for the Havre de Grace Racetrack in Maryland.

GLENY CAIN OAKFORD: In some ways, she’s kind of an unassuming looking mare in that she’s not a particularly flashy color. She’s what’s known as a dark bay. She’s a beautiful deep brown. She has a white star in the middle of her forehead. She’s extremely attractive. She has immense presence about her, and she did have one of the best race records of any filly or mare that has ever run in American horse racing. She earned more than $2.5 million, and importantly for this auction, she has a great female family behind her. It’s a super productive family, and this is hugely important to people who are looking to buy broodmare prospects. She was leaving the racetrack and going into the next part of her career, which was to be a broodmare. And so at that point, her pedigree and what her previous female ancestors have produced becomes enormously important to people who are looking to buy her.

KATY MILKMAN: While other horses come and go during an auction event like this, the bidding stakes go way up when a prized horse is on the line.

GLENY CAIN OAKFORD: It’s very different when a horse like Havre de Grace comes into the auction ring. There’s a sort of solemnity that takes over, and at this particular sale, the auctioneers really built on that, because before she even entered the ring, they played a video recapping how wonderful her accomplishments were, how wonderful her female family is, her excellent pedigree, the beauty of her looks. So they really built that up so that when the doors open and she actually walked into the ring, that solemnity had really reached a level of being awe-inspiring.

KATY MILKMAN: At moments like these, the atmosphere becomes electric, the seats fill up, the media snaps to attention, and a hush falls over the room.

GLENY CAIN OAKFORD: It’s generally very quiet and deadly serious feeling, so the tension ratchets up a notch, and it’s a lot of fun to witness as a spectator as well. But you can almost feel the nerves among the bidders who are preparing to actually do battle.

KATY MILKMAN: It’s not just the bidders who are feeling the pressure and excitement.

GLENY CAIN OAKFORD: There were a lot of racing fans. There was a lot of media, both inside the thoroughbred industry and general media who were there to see this because everyone knew that it was going to be a special moment. So I took my place standing toward the back of the auction ring so that I could see the whole crowd. All of us in the media knew basically where most of the major players tended to congregate to place their bids. So we wanted to make sure they were all there, and of course they all were.

TERENCE COLLIER: Ladies and gentlemen, we present Havre de Grace. Let’s have her in. Now, we’re going to ask you for a little quiet as we offer this wonderful mare. She has shown the greatest decorum …

KATY MILKMAN: As you can imagine, an auction hall is generally not the calmest environment for a horse.

GLENY CAIN OAKFORD: They had asked for people to be quiet and to not applaud before she came in, because horses can be flighty, and an auction ring is not a setting that most horses are really used to. And so it was important, I think, that they let her acclimate to the crowd before they actually started. And so funnily enough, that quiet actually raised the tension level too. I think you could almost hear people’s heartbeats throughout the pavilion, because everyone was so excited to see her.

AUCTIONEER: [auction chant] All right … auction’s on … turn it up a little bit, Jerry … one down … 500 … now a million … at 500 … turn it up, Jerry … 500 … now a million …

GLENY CAIN OAKFORD: The opening bid was actually 500,000, and then they were off. It took off from there. Once the bidding actually takes off, it’s very heart pumping.

AUCTIONEER: [auction chant] 3 million … now 3 … give me 3 … 3 … 3 …

KATY MILKMAN: The bidding was fast and furious initially. The auctioneer got the lower dollar amounts out of the way quickly, as most bidders had a sense of what Havre de Grace was actually worth.

GLENY CAIN OAKFORD: I think people probably, if you had asked them to nail down a figure, would have said it would have been 7½ to 8 million. That seemed to be the valuation that was kind of going around. So each bid that was placed from that opening bid was for a half million dollars, which is pretty extraordinary. You don’t often see people bid in increments that huge, but everyone knew her price was going to be large.

AUCTIONEER: [auction chant] 4, 5 … now 5 … 5 million … 5 million … 5 million, now 5 million …

GLENY CAIN OAKFORD: It got to $5 million and then slowed to $200,000 and $300,000 increments. So the pace had slowed a little bit, but it was still considerable. It paused at 6.7 million and then picked up again, and then when the price hit 7 million, there was a very long pause.

AUCTIONEER: [auction chant] 7 million and 1. That’s 7 million and 1 … how could you come this far and not get her?

GLENY CAIN OAKFORD: And at that point, everybody who was in the room who was still live on the mare was stopping to consult. People were beginning to assess really how much had they valued her for, really how much were they willing to spend? What was the next move that should take place? So at 7 million there were quiet conversations going on among people, and at that point, the auctioneer’s announcer, Terence Collier, said …

TERENCE COLLIER: I tell you what, I don’t want you to pull the trigger yet, because there are so many people on the telephone right now …

GLENY CAIN OAKFORD: “I don’t want people to pull the trigger just yet, because there’s so many people who are still live on this mare.” And he starts to talk. Now that, again, is by design because he is aware that things have gotten very serious.

AUCTIONEER: [auction chant] 1, 2, 7-2, 7-2, 7-2, 7-2 …

GLENY CAIN OAKFORD: So once bidding resumed, past 7 million, it was apparent that there were still several live bidders. It hadn’t quite settled down to two people, which normally in a horse auction, once you hit that level of the atmosphere, you only have, normally, two people left. But there were believed to be three or four who were still live at that point.

AUCTIONEER: [auction chant] 9-5 … Tom, you’re running second … 9-5 … would you give 9-7? … you’re out now. That’s 7 … 10? … you want to give 10 million? … that’s the way now, 10 ...

KATY MILKMAN: The bidding had reached $9.7 million. The auctioneer was calling for 10 million. At this point, it was down to two bidders.

GLENY CAIN OAKFORD: One of them was Mandy Pope. The other was Benjamin Leon, who has a stable called Besilu Stables. It eventually ended up more or less down to them. It ended up at 9.7 million. There was a small pause.

AUCTIONEER: [auction chant] 10-1? …

TERENCE COLLIER: Folks, hold your applause here, when this hammer falls, please. Let’s get the mare out of the ring first.

AUCTIONEER: [auction chant] 10-1? … thank you. They done, Tom? Got to go. 10 million 100? He’s through. Well, thank him for what he did do. You made us a great underbidder. $10 million even ...

GLENY CAIN OAKFORD: Mandy Pope bid $300,000, and that sealed the deal. It stayed with Mandy Pope, and the hammer fell at $10 million.

KATY MILKMAN: $10 million. This was a very high price.

GLENY CAIN OAKFORD: The magnitude of it was pretty extraordinary. Again, it was roughly 2, $2½ million more than people had allowed themselves to believe she was going to go for. And I think it was more than the vast majority of people thought she would bring, and it was just a staggering number.

KATY MILKMAN: This was a remarkable and exciting moment, but how did the winning bidder feel about what had just transpired? Glenye was standing near Mandy Pope during the auction.

GLENY CAIN OAKFORD: She was mobbed immediately by all the press. She said, “I was nervous. I’m still nervous. I’m totally overwhelmed.” But she said, “It’s a once-in-a-lifetime shot, and I’m taking a shot at it, and we’ll see what happens.” And really that’s all anyone can do in the thoroughbred breeding business.

KATY MILKMAN: OK, so it’s not everyone who can just decide to spend $10 million on a horse at an auction, but I want to pause for a minute and take stock of the situation. The value people were discussing before the auction was 7 to $8 million. It makes sense that there would be some low-ball bids, in hopes of getting a good deal. It also makes sense that some of the bidders would keep bidding up to the 7 or $8 million mark, since that seemed to be in the range of a reasonable value.

So why did this auction go well over the price that most seemed to agree was reasonable? We’ll get to a potential explanation for that in a bit, but first, I want to get a sense of whether or not Mandy Pope’s investment has paid off. Mandy Pope breeds racehorses under the name Whisper Hill Farm. She’s been in the thoroughbred business for 30 years, so she was no amateur at these types of auctions. That said, she also doesn’t come across as a high roller.

GLENY CAIN OAKFORD: She loves horses, and that comes across when you meet her. She’s a little bit unassuming. She doesn’t walk through the sale grounds with a huge entourage, and when she speaks about the horses that she’s purchased or owns, or even is considering buying, she speaks of them in terms of their presence and their personality, and she’ll feed them mints.

KATY MILKMAN: Clearly, Mandy Pope loves the world of thoroughbred horses, and she has the resources to make these high-value bids. But even so, it’s interesting to ponder the return on her investment in Havre de Grace.

GLENY CAIN OAKFORD: Well, I should say at the outset, that it’s still pretty early days yet, in terms of her production as a broodmare. She sold in 2012, and one thing that’s important to understand is that the gestation period for a horse is 11 months. So it takes a long time when you are breeding horses to ever see a payoff. You breed your mare. Eleven months later she has a foal. You pay the stud fee, and probably you’re not going to sell that foal, if you do intend to sell, until it’s at least a weanling.

KATY MILKMAN: A weanling is a foal that has just been weaned, usually between six months and a year. Once it’s a year old, the horse is referred to as a yearling.

GLENY CAIN OAKFORD: More often people will sell as yearlings, and they don’t run until they’re two years old. So you can see that the time horizon for any kind of return on this sort of investment is really lengthy.

KATY MILKMAN: While the time horizon is long, we have a sense for how the investment is going so far.

GLENY CAIN OAKFORD: Her first foal was born in 2015. His name is Riverfront. She put him into a sale in 2016. He had a final hammer price there of $1.9 million but did not reach his reserve on that price.

KATY MILKMAN: The reserve price is the minimum amount to sell, which was in this case higher than 1.9 million.

GLENY CAIN OAKFORD: That meant that he didn’t sell. He went on to run. He won a race. He won a race when he was age 4, and he’s earned, so far, a total of $38,430. That’s as of today. So again, not a huge payoff in terms of his race earnings, and obviously he didn’t sell. And so no payoff in the auction ring. Her most expensive foal through the auction ring so far was a colt whose name is Marvelous Guy—sold in 2018 at the Keeneland September Yearling Sale for $550,000 to a Japanese buyer. So that was quite a good price, but when you’ve paid $10 million for the mare, and then you’ve been putting stud fees in her too. It’s … obviously you’re not getting out of a $10 million purchase price with one yearling selling for $550,000. She’s had six foals in total. Three of those have won. Again, that’s not a terrible record, but none of them has become a world beater. None of them has won Grade 1 races, which are the top level races in the country.

I think a lot of people probably looking at the race records would have predicted and hoped that they would have run to their pedigrees. They have not so far done that, but again, it’s fairly early days.

KATY MILKMAN: So if you add up the money earned so far, at least the money that we know about, Mandy Pope hasn’t come close to her $10 million investment, and that’s seven and a half years in. Of course, it’s still possible that Havre de Grace will produce some very valuable foals, and Mandy Pope may still make her money back, but it’s not looking great. A typical broodmare can produce 10 to 12 foals.

GLENY CAIN OAKFORD: Once you start paying 7, 8, $10 million for a horse, it can be very, very difficult to ever realize a return on that.

KATY MILKMAN: Glenye Cain Oakford is an award-winning journalist, writer, and videographer based in Lexington, Kentucky. She was the senior bloodstock correspondent at the Daily Racing Forum at the time of the legendary horse auction I just described.

Mandy Pope’s $10 million bid for Havre de Grace won her the auction, and her investment may pay off in the future. Although at this point, with this particular horse, it doesn’t seem likely. But there’s an interesting lesson. It’s about a common feature of auction sales. The winner often ends up paying substantially more than the generally agreed upon value of the item that’s up for sale. This phenomenon is called the winner’s curse. It was first identified in the 1970s around oil drilling leases in the Gulf of Mexico. It turned out that in these competitive auctions, the winning bidder often paid more for the lease than the value of the oil and ended up losing money on the project.

We saw this behavior in our auction experiment at the beginning of the episode too, where a few people were willing to bid quite a bit more for a jar of coins than it was actually worth. Naturally, the highest bidder won the jar, but the jar was only worth half of her bid, a clear loss.

That experiment is based on work by Max Bazerman and William Samuelson, who demonstrated the two key ingredients that drive the extent of overpayment. First, the number of bidders in the auction, and second, the degree of uncertainty about the value of the commodity being sold.

Max Bazerman is a regular guest on Choiceology, who’s done some of the most important research on the winner’s curse. He joined me from his home in Cambridge, Massachusetts, to talk about the science behind this decision-making trap.

Hi, Max. Thank you so much for joining me today. I really appreciate it.

MAX BAZERMAN: Why, thank you. It’s terrific to be with you again.

KATY MILKMAN: So, I just want to start with the basics. Could you start by just defining for us what the winner’s curse is?

MAX BAZERMAN: I think it’s easiest to provide a definition after an example. So imagine that you’re in a foreign distant land, and you are walking down a tourist street, and you see a terrific piece of jewelry in the window. And you go into the store and you ask about the price, and the owner says, “Haven’t put a price on it yet, but if you make me a reasonable offer, I’ll do my best to accept it.”

And you think that this piece of jewelry is worth perhaps 5 to $10,000. And so you offer them $1,000. And their response is, “Great. We have a deal.” And anybody who’s ever purchased a piece of jewelry off the street in a far distant land will say, “That’s a problem.” The fact that they took your offer without even haggling with you tells you that your offer was too high to begin with. And this very, very simple example highlights the idea of the winner’s curse.

KATY MILKMAN: So what evidence do we have that this is a real bias, this winner’s curse, and that it meaningfully affect people’s decisions?

MAX BAZERMAN: I think that we have enormous evidence from lots and lots of different areas. The idea of a winner’s curse was first published in a paper by Clapp, Capen, and Campbell, where they showed that when lots of bidders bid on offshore oil leases, the winning bidder ends up paying far more than the oil lease is worth, on average. So the simple idea here is that when there’s lots of bidders bidding in an auction on one commodity, the person who wins the auction isn’t the person who was the best estimator. The winner of the auction tends to be somebody who most overestimated the value of the item being auctioned to begin with.

So if you imagine 1,000 people bidding on some pretty uncertain commodity, and you ended up being the highest bidder, and I now say to you, “What does that tell you about your estimate?” People can all of a sudden realize that they were probably one of the highest estimators. And unless they have very good estimation skills, that probably also means that they overpaid as a result.

We can turn to bidding on a right fielder for your baseball team, or a painting, or lots of different contexts, but the punchline is when lots of people are bidding on some target in an auction where the value is highly uncertain, the winning bidder typically pays more than it was worth for them to make that acquisition.

KATY MILKMAN: It sounds like the takeaway from this is I should never enter an auction, because if anyone else is entering too, I’m only going to win if I pay too much. Is that an accurate takeaway? Should I just stay away from auctions, or do you think there’s something else I should be focused on here?

MAX BAZERMAN: So I would say that’s a bit of an overstatement, so I would change it from never to you should be cautious about auctions, and you should be particularly cautious about auctions that are for commodities where the value of the commodity is highly uncertain and where there’s lots of bidders. If there’s only a few bidders, then I think you could be in good shape. If you have a very good idea of the true value of what you’re bidding on, then you could be in good shape. But when you have lots of people bidding on a commodity of uncertain value, then you should be cautious.

I would also say that you said never bid, and I wouldn’t say never bid. Imagine that you’re looking at a rug on eBay and you really like it, and it’s not very expensive. It’ll cost $200, and you think it’ll look pretty on your floor. If you want to be the highest bidder and even pay 250 for it if necessary to get it, because you think you’ll enjoy it, that may be a fine decision. But if you think you’re getting a great value, and there’s lots of bidders and you have uncertainty, then I think you should question your thoughts on that.

KATY MILKMAN: So I’m hearing then … probably to get deals, auctions can be more dangerous, but when there’s something that I might value personally more than other people because I have a certain aesthetic sense or it has some emotional meaning for me, then I shouldn’t really worry so much about valuation. I should focus on other things, and then I don’t need to worry as much about the winner’s curse. Is that a reasonable summary?

MAX BAZERMAN: Very nicely said. And I would add to what you said to say anytime you have idiosyncratic value because the item is worth more to you than to anybody else—that should give you a reason to be less concerned about overpayment because you’re getting some incremental value that isn’t available to anybody else out there.

KATY MILKMAN: I want to talk a little bit about why this arises. It basically seems like it’s a property of statistical distributions, but could you dig in a little bit to what causes this winner’s curse to pop up?

MAX BAZERMAN: Sure. I think so. So I like wine. I’ve actually never been to a wine auction, but let’s assume I go to a wine auction, and there’s a case of wine that I don’t really know what it’s worth, but my guesstimate is $1,000. So I do what a lot of people in auctions do, is I decide, I’ll bid up to $900, because at $900 I’m getting a good value, given that I think it’s worth $1,000. So far, that makes sense.

But now let’s imagine that there’s obviously a lot of other bidders who are bidding in the auction for the same case of wine, and some of them might even know a lot more than I do now. Now, it turns out that there’s lots of ways to learn about the value of wine. I could use my iPhone and look up the values pretty quickly, and that could provide me comfort by reducing the uncertainty about the commodity, but if I’m in a context where the uncertainty remains and there’s lots of bidders, I shouldn’t take comfort in there being lots of bidders, and a lot of people do. A lot of people basically see the other bidders as validation that the item in fact is worth a lot, but in fact, if you end up lasting and ending up as the highest bidder, you’ve probably overpaid in that context. And we all know that when we get into auctions, we might decide that it’s worth a thousand, I’ll pay up to 900, but we get excited and we ended up paying 1,100 instead because we get affected by the heat of the auction. But now let’s go back to the analytics of this story.

Imagine for a minute that I see that there’s 12 people bidding on the wine. If I stop and think about, what does the distribution look like of the estimates of those 12 people? We might think of what the statisticians call a normal distribution with some variance around the mean. And the mean may well in fact be a pretty good representation of what the true value of the commodity would be. But now notice that you have some people estimating high, some estimating low—who ends up winning? It’s not a random person from the distribution. It’s a bidder who was probably the highest estimator or near the highest estimator. So the winning bidder of auctions tends to be somebody who significantly overestimated the value to begin with. So unless we can get more certainty about the value, I think that we are at risk when we bid in auctions.

KATY MILKMAN: And Max, we’ve talked a lot about the impact of the winner’s curse on how we should think about auctions. And you’ve talked a little bit about how it relates to negotiations, but I’m curious what you think the most important takeaways are for someone who is thinking about negotiating, say, for a house that they’d like to buy or even a car that they’re hoping to buy that is on sale in a competitive process. What are the negotiation takeaways from this research on the winner’s curse?

MAX BAZERMAN: Sure. So in the abstract, one of the most important principles of being an effective negotiator is to think about the decisions of the other party. And a lot of people when they hear that, they’ll nod their head and think that that’s pretty obvious. And you might’ve even had a mother who told you to put yourselves in the shoes of others. But what ample research shows is that most negotiators don’t spend enough time thinking about the decisions of the other party. Imagine a situation where you get a job offer in a new city, and life is very busy, and you have a weekend to travel to that city to look at houses. And you look at 16 houses over that weekend, and there’s one house that you like more than the others, and you make an offer.

And my quick-thought question is, who knows more about the value of that house—the buyer or the seller? And I would argue that sellers typically know far more than the out-of-town buyer. And this is, again, a situation where the buyer needs to be aware of their lack of information and to find a way, either through friends or through professional advice, to make sure that they know the value of what it is that they’re bidding on. Otherwise, the seller of the house is most likely to accept it when you least want them to, when in fact the house was overpriced to begin with.

KATY MILKMAN: Max, this was so fantastic. Thank you for joining us again and for being such a wonderful guest. Really appreciate it.

MAX BAZERMAN: Thanks, Katy, you’re always great to talk with.

KATY MILKMAN: Max Bazerman is the Jessie Isidor Straus Professor of Business at the Harvard Business School and the Harvard Kennedy School and the author of many wonderful books, including Better, Not Perfect, which will be released later this year by Harper Business. I have links in the show notes and at schwab.com/podcast.

It can also be easy for investors to fall into behavioral traps, but the key to long-term investing success is usually having a plan and sticking to it. On our sister podcast, Financial Decoder, host Mark Riepe and his guests share strategies for avoiding the behavioral traps that could imperil your portfolio and derail your financial goals. Check it out at schwab.com/financialdecoder or wherever you listen to podcasts.

As Max mentioned, the winner’s curse is hard to avoid. That’s because the highest bidder is very often the bidder who most overestimated the value of the asset that was being auctioned off. So it’s important at the outset of any negotiation or competitive bidding process to determine if what you’re trying to buy has idiosyncratic value to you. If it does, the risk of the winner’s curse has lessened, but if the asset is equally valuable to everyone bidding, the risk of the winner’s curse is often quite high.

Now, if you’re bidding on an asset that has the same value to everyone, even if that value is unknown, you might be able to avoid the curse if you’re better positioned than other bidders to leverage that value. Say you overbid on a fixer-upper home, but you’re a contractor and can do the renovations for a fraction of the market price. That way, you’ll end up with a more valuable home in the end. Naturally, you can also reduce the chances that you end up facing the winner’s curse by really doing your homework on the asset’s value and sticking with your top price even in the heat of the moment. Finally, before you make a bid, it may be useful to imagine yourself having already won the auction. Remember, by winning, it means all of the other bidders value the item less than you do. If that scenario makes you uncomfortable, it may be wise to sit this one out.

You’ve been listening to Choiceology, an original podcast from Charles Schwab. If you’ve enjoyed the show, we’d be really grateful if you’d leave us a review on Apple Podcasts. It helps other people find this show. You can also subscribe to the show for free in your favorite podcasting apps. Next time we’ll look at some simple but effective strategies to make the hard work of striving for long-term goals more effective and more fun. I’m Dr. Katy Milkman. Talk to you next time.

SPEAKER 15: For important disclosures, see the show notes or visit schwab.com/podcast.

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