In numerous auction settings potential bidders incur costs to enter the auction. Such costs may potentially influence bidder’s behavior subsequently. In this paper we experimentally study the effect of entry costs on bidding and entry behavior, through a complete information common value auction. We run first and second price auctions both with and without entry costs. We find that with entry costs, players on average bid lower in first price auctions, while in second price auctions the average bids are higher, compared to bids in the corresponding no entry fee auctions.Common Value Auctions, Entry Costs, Experiments

Sudeep Ghosh

Surajeet Chakravarty

English

Research Papers in Economics

Economics Department 
Discussion Papers Series 
ISSN 1473 – 3307 
 
An Experimental Investigation of Entry Cost 
Effects in Sealed Bid Dollar Auctions  
 
 
Surajeet Chakravarty and Sudeep Ghosh  
 
 
 
Paper number 10/07 
URL: http://business-school.exeter.ac.uk/economics/papers/ AN EXPERIMENTAL INVESTIGATION OF ENTRY COST EFFECTS IN SEALED
BID DOLLAR AUCTIONS
SURAJEET CHAKRAVARTY† & SUDEEP GHOSH‡§
ABSTRACT. In numerous auction settings potential bidders incur costs to enter the auction. Such
costsmaypotentiallyinﬂuencebidder’sbehaviorsubsequently. Inthispaperweexperimentallystudy
the effect of entry costs on bidding and entry behavior, through a complete information common
value auction. We run ﬁrst and second price auctions both with and without entry costs. We ﬁnd that
with entry costs, players on average bid lower in ﬁrst price auctions, while in second price auctions
the average bids are higher, compared to bids in the corresponding no entry fee auctions.
KEYWORDS: Common Value Auctions, Entry Costs, Experiments
† Department of Economics, University of Exeter, Exeter EX4 4PU, UK. E-mail: s.chakravarty@exeter.ac.uk
‡ Faculty of Business, Hong Kong Polytechnic University, Kowloon, Hong Kong. E-mail: afsghosh@polyu.edu.hk
§ We thank Ngai Ho Lam for providing programming assistance with the experiment. We also thank Gauthier Lanot
and various conference and seminar participants for their comments on the paper.
11. INTRODUCTION
Entry costs are often observed in real-life auctions. For example, contractors in procurement
auctions may have to pay a registration fee to the auctioneer in order to establish their viability
or potential bidders may incur bid preparation costs. We investigate bidding behavior in complete
information two player common value auctions, equivalent to a sealed-bid dollar auction, through
laboratory experiments. Running such an auction allows us to have a simple design, facilitates
analysis and control for winner’s curse. We study the effect of entry costs on bidding and entry be-
havior in both ﬁrst and second price auctions. While conventionaldollar auctions exhibit escalation
of commitment effect on bids, sealed bid dollar auctions are not expected to show such effect.
There have been experiments which have studied entry costs and biding behavior in auctions,
mostlythrough privatevalueauctions (see Phillips et al. (1991),Palfrey and Pevnitskaya(2008)). In
a format closer to ours, Cox et al. (2001) look at entry, exit and bidding behavior through ﬁrst price
common value auction. But unlike our experimental design, they have an incomplete information
common value auction with private signals in order to investigate winner’s curse and we study
second price auction as well. Another related paper is Levin and Smith (2001) which looks at
entry decisions through incomplete information common value ﬁrst price auction. Apart from the
informational difference, in our design the potential bidders face minimal uncertainty regarding
the number of players in the auction, when they make the entry decision.
1 Finally, (Drichoutis et
al., 2008) analyzes willingness to pay of agents in second price auctions through the use of reserve
prices.
In each auction, ﬁrst and second price, we run a conventional winner pay auction and a ﬁxed
entry fee one. We study if this entry cost has an effect on bids. Interestingly, we ﬁnd that the bids in
the ﬁrst price auction with entry fee falls in comparison to the auction without the entry fee, while
in second price auction, the bids in the auction with entry fee increases in comparison to the auction
without the entry fee.
2. DESIGN
We ran two-player complete information common value ($25) auctions.
2 The subject pool con-
sisted of studentsdrawn randomly on a volunteerbasis. We had a 2×2 design, where one treatment
1Post-entry number of players in the auction is explained later in the section on design.
2Note all amounts are in HK$, where 1 US$ ≅ 7.8 HK$.
2variablewas thenature of theauction (ﬁrst orsecond price)and theother was auctions with orwith-
out entry costs. In case of the entry fee auctions, subjects had a choice to either enter by paying $5
or not enter. Subsequently, all entrants were randomly assigned to groups of two. If odd number
of subjects entered, one group was assigned three subjects. If only one subject entered, then the
auction in that round was canceled. Both subjects in a group simultaneously bid for the prize of
$25. In treatments without an entry fee, subjects were randomly matched into groups of two, prior
to their bid decisions. Each treatment had multiple identical rounds (varying from 6-8 rounds), but
all subjects were re-matched after every round. Finally, subjects were given an endowment of $50
at the beginning of each treatment in order to cover their potential entry costs.
In the ﬁrst price auctions, the highest bidder in a group won the auction and earned a payoff
of $25 minus their own bid and entry fee (if any). In the second price auctions, again the highest
bidder in a group won the auction, but earned a payoff of $25 minus the other player’s bid and
entry fee (if any). The other bidder, both in ﬁrst and second price auctions, earned a payoff of zero
or had losses equal to the entry fee (if any). Once all subjects in a group submitted their bids, the
highest (winning) bid was revealed to all players within the group and each player’s payoff from
the auction was privately revealed. To summarize, the following treatments were run:
FP: First Price Sealed-Bid Auctions:
FP NEF: No entry fee
FP FEF: Fixed entry fee of $5
SP: Second Price Sealed-Bid Auctions:
SP NEF: No entry fee
SP FEF: Fixed entry fee of $5
3. RESULTS
Table 1 provides the descriptive results. To remove outliers, we trim 5% each of the highest
and lowest bids for each treatment. The average bid for the ﬁrst price auction with no entry fee
(NEF) is 20.5, while with ﬁxed entry fee (FEF) the mean bid is 18.4. Corresponding median bids
are 21 and 19 respectively. A t-test for equality of means conﬁrms that differences in the mean
bids are signiﬁcant (at 1% level), while a Wilcoxon test for equality of median conﬁrms the same
for median. For the second price auction the average bid in NEF treatment is 25.8, while in FEF
treatment its 30.1. The corresponding median bids are 25 for both treatments. We also ﬁnd over-
bidding in the second price auction compared to the weakly dominant strategy of bidding the true
3TABLE 1. Descriptive Data from First Price & Second Price Auctions
First Price
Auctions
Second Price
Auctions
NEF FEF NEF FEF
# of Auctions 451 365a 661 141a
Entry % na 58.34 na 39.75
Mean Bid 20.5 18.4 25.8 30.1
Median Bid 21 19 25 25
Mean Entrant Earnings 1.67 -2.17b 1.02 -3.93b
a post-entry
b net $5 entry fee
valuation of $25, irrespective of the entry fee. Previously reported overbidding in second price
auctions is commonly attributed to winner’s curse (see Kagel (1995)), but being a dollar auction
there is no winner’s curse in our design.
(a) Box-Plot Representation of Bids (b) Empirical Quantile Distribution of Bids
FIGURE 1. Bid Characteristics
4The bid characteristics are highlighted through ﬁgure 1. Figure 1(a) shows a box-plot for the
distribution of bids, disaggregated over initial (1-3) and ﬁnal rounds (4-8). Figure 1(b) gives the
empirical quantile distribution of bids for each of the four treatments. Figure 1 reveals that both
in ﬁrst and second price auction there is a signiﬁcant effect on bids in the presence of an entry
fee3. This effect is robust across rounds (initial or ﬁnal), though it is more robust for ﬁrst price
than for second price price auction.4 Interestingly, the bids in the ﬁrst price auction fall on average
(conservative bidding) with the introduction of a ﬁxed entry fee, while in the second price auction
they rise on average (aggressive bidding) in the presence of the ﬁxed entry fee.
Next, we segment the population of subjects based on their entry decisions separately for the ﬁrst
price and second price auctions. The objective is to ascertain whether the observed difference in
bids in the entry fee auctions compared to the no entry fee ones is due to a “self-selection” effect
or due to the strategic impact of the entry fee on subjects’ subsequent bids. The “self-selection”
effect pertains to whether those subjects more likely to enter an auction with participation costs are
also the type who are innately more conservative/aggressive in their bidding in general. We ﬁrst
calculate the entry percentage over all rounds for each subject. We then analyze the correlation
between the entry percentage for a subject in the ﬁxed fee treatment and the bids for the same
subject in the no entry fee treatment of the same auction. If those subjects with a higher entry
percentage are also innately more conservative/aggressivebidders, then that behavioral trait should
be demonstrated irrespective of whether the auction has an entry fee or not.
TABLE 2. Correlation Coefﬁcients for First Price & Second Price Auctions
Correlation Coefﬁcients
First Price Auctions Second Price Auctions
entry % and NEF bid 0.09 0.194
3Since the entry fee acts as a sunk-cost for the actual action, the difference in bid distribution between entry fee and no
entry fee treatments can be characterized as a failure by subjects to ignore sunk costs.
4To test robustness we also ran a endogenous entry fee treatment for ﬁrst price auction, where subjects had to indicate
how much they were willing to pay in order to participate in the common value auction. Those subjects whose willing-
ness to pay were in the top 60%, automatically entered the auction after paying their indicated amount. We found that
there was a signiﬁcant negative correlation between subject’s willingness to pay in order to enter the auction and their
actual bids in the auction subsequent to entry.
5Table 2 shows the correlation data for likelihood of entry (in the entry fee treatment) and bids in the
no entry fee (NEF) treatment for each of the two auctions. We observe that the correlation between
entry and bids (averaged across all rounds for each subject) is close to zero for both the ﬁrst and
second price auctions. We can reject the hypothesis that a predilection towards entry is correlated
with bidding behavior.
FIGURE 2. Entry Levels in First and Second Price Auctions with Entry Fee
Finally, we analyze the entry decision in both the ﬁxed fee ﬁrst and second price auctions. Figure 2
reveals that entry levels falls over rounds in both the auctions, though the fall in entry is larger for
second price. This can be interpreted as a “learning effect,” where subjects ‘learn’ to stay out of
an auction whose equilibrium predicted expected earnings are negative (equal to the entry fee). We
should then expect entry in any round to be negatively inﬂuenced by cumulative number of losses
in previous rounds where entry occurred. Another determinant of entry could be the cash balance
of a subject at the beginning of the round. Phillips et al. (1991) interprets this as a variant of the
“endowment effect,” arguing that those with higher endowments (cash balance at the beginning of
the auction) would be less likely to take the risk of entering the auction. This would imply that past
losses (i.e., lower current cash balances) would have a positive effect on the current entry decision,
contrary to the “learning effect.” To test these competing claims we use the following Probit model
6for entry:
DENTRY = α1+β11NUMLOSS+β22BEGCASH (1)
where, in the above equation 1, DENTRY is an indicator variable that takes the value of one if
entry occurs in that round and zero otherwise. NUMLOSS is the ratio of number of cumulative
losses in the auction (i.e. failure to win) in previous rounds to cumulative past entries. BEGCASH
is the cash balance at the beginning of the round. We run the above regression on the combined
data from ﬁxed entry fee ﬁrst and second price auctions.
TABLE 3. Probit Regression Results for Entry
DENTRY
Constant 0.968***
(0.085)
NUMLOSS -0.236***
(0.069)
BEGCASH 0.001
(0.001)
#Obs 882
S.E. of regression 0.393
*** Denotes signiﬁcance at
1%level. Numberinsideparen-
thesis denotes std. error
Table 3 shows that the coefﬁcient of NUMLOSS is negative and signiﬁcant while, the coefﬁcient
of BEGCASH is positive but not signiﬁcant. From the data we can conclude that “learning effect”
(of past losses) is a signiﬁcant determinant (negative) of entry, while “endowment effect” is not.
4. CONCLUSION
We ﬁnd that entry costs inﬂuence the actual bids in auctions, contrary to theoretical prediction.
Interestingly, we ﬁnd a strong negative correlation between entry fee and actual bids in the ﬁrst-
price auction and a positive correlation with entry fee and bids in second price auction. So bidding
behavior with entry costs is more aggressive in second price auction and more conservative in ﬁrst
price auction.
7REFERENCES
Cox, J. C., S. Dinkin, and J. T. Swarthout (2001)‘Endogenousentry and exit in commonvalue auctions.’ Experimental
Economics 4(2), 163–181
Drichoutis, Andreas C., Panagiotis Lazaridis, and Rodolfo M. Nayga Jr. (2008) ‘The role of reference prices in experi-
mental auctions.’ Economics Letters 99(3), 446 – 448
Kagel, J. H. (1995) Auctions: A Survey of Experimental Research
Levin, Dan, and James L. Smith (2001) ‘Entry coordination in auctions and social welfare: An experimental investiga-
tion.’ International Journal of Game Theory 30, 321–350
Palfrey, Thomas R., and Svetlana Pevnitskaya (2008) ‘Endogenous entry and self-selection in private value auctions:
An experimental study.’ Journal of Economic Behavior & Organization 66(3-4), 731 – 747
Phillips, O. R., R.C. Battalio, and C.A. Kogut (1991) ‘Sunk and opportunity costs in valuation and bidding.’ Southern
Economic Journal 58(1), 112–128
8APPENDIX A
INSTRUCTIONS FOR THE EXPERIMENT
This is an experiment in market decision-making funded by a research grant. During the experi-
ment you will be called upon to make some decisions. Your earnings will be determined by your
decisions and the decisions of the other participants. If you listen to the instructions and follow
them carefully you stand to make a substantial sum of money. At the end of the experiment you
will be paid in cash all the money you earn including the $50 you get for participating.
The experiment will consist of several games, all of which involve some type of an auction. Each
game will consist of a speciﬁed number of identical rounds. In each game you will be matched
with other participants in a group, such that before each round of a game you will be randomly
rematched with other participants. If the number of participants are even then you will always be
in a group of two5, otherwise one group will have three participants and the rest will have two. The
number of participants in your group will be displayed at the top of the screen. In case there is only
one participant, then there is no auction and hence no payoff for that round.
In each round of a game, the participants in a group will submit a bid for a prize of $25. The
earnings for each participant will depend on their bid and the bids of all other participants in their
group. The way the earnings are calculated will vary across games and will be speciﬁed before
each game. At the beginning of the experiment you will be paid $50. If your earnings fall below
-$50 at any point during the experiment, you will not be allowed to continue with the rest of the
experiment.
We will have 5 practice rounds at the beginning of each game to enable you to familiarize yourself
with the decision-making process of the experiment.
Any questions?
5To begin with in all sessions the number of subjects were kept even. But in the auctions with entry fee it was possible
that an odd number of subjects could decide to enter.
9Second price auction with no entry fee (SNEF)
You have to make a bid, which can be any non-negative number. If your bid is the highest in your
group then you win the prize. If your bid is not the highest then you do not win. In case your bid
and the bid of the other person in your group are the same, then one of you is chosen at random to
be the winner.
The winner in each group earns a payoff of $25 minus the bid of the other player in their group.
The other player gets zero. At the end of each round you are told if you won and your payoff. You
are also told the winning bid.
This is run for x6 identical rounds, where before each round you are randomly rematched with
another participant.
Any questions?
First price auction with ﬁxed entry fee (FFEF)
You are offered participation in an auction with a prize of $25 for the winner in each group. In each
round, in order to participate you have to pay an entrance fee of $5. If you decide not to participate
you do not have to pay anything and you just sit out for that round. If you decide to participate by
paying $5, you enter the auction and get matched in a group with another participant (one group
could be of size three).
Once you enter the auction you have to make a bid, which can be any non-negativenumber. If your
bid is the highest in your group then you win the prize. If your bid is not the highest then you do
not win. In case your bid and the bid of the other person(s) in your group are the same, then one of
you is chosen at random to be the winner.
The winner in each group earns a payoff of $25 minus their own bid. The other participant(s)
gets zero. At the end of each round you are told if you won and your payoff. You are also told the
winning bid. This is run for x rounds, where before each round you are randomly rematched with
another participant.
Any questions?
6The number of rounds varied from 8-10 for all treatments.
10First price variable entry fee auction (FVEF)
You are offered participation in an auction with a prize of $25 for the winner in each group. In each
round in order to participate you have to submit an amount you are willing to pay as an entrance fee
for the right to participate in the auction. An amount equivalent to their bid for the entrance fee
is automatically deducted for all participants. The top y7 amongst you in terms of the entrance
fee bids get to participate in the auction. The participants who are unable to make it to the auction
have to sit out for that round.
If you are in, you will be matched with another player in a group of size two (one group could have
3 participants). You have to make a bid, which can be any non-negative number. If your bid is the
highest in your group then you win the prize. If your bid is not the highest then you do not win. In
case your bid and the bid of the other person in your group are the same, then one of you is chosen
at random to be the winner.
The winner in each group earns a payoff of $25 minus their own bid. The other player gets zero.
At the end of each round you are told if you won and your payoff. You are also told the winning
bid. This is run for x rounds, where before each round you are randomly rematched with another
participant.
Any questions?
The other treatments, ﬁrst price auction with no entry fee and second price auction with a ﬁxed
entry fee had similar instructions.
7In each session of this treatment the number y was chosen such that a total of 60% of all subjects got chosen as
participants.
11

An Experimental Investigation of Entry Cost Effects in Sealed Bid Dollar Auctions

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An Experimental Investigation of Entry Cost Effects in Sealed Bid Dollar Auctions

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