Game of Auctions and Winner’s Curse

Did Vijay Mallya overpay during IPL auction? Is Yuvraj Singh really worth Rs.14 crores? I am sure, post auction; Vijay Mallya is suffering from “winner’s curse”- common phenomenon in game of auctions. After auction Vijay Mallya tweeted that he had overpaid by few crores! I am sure few crores mean a lot to employees of his bankrupt airline company.

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There are various types of auctions, most common is English auction. In English auction, participants bid openly against one another, with each subsequent bid required to be higher than the previous bid. The auction ends when no participant is willing to bid further, at which point the highest bidder pays his bid.

The auctioned item is of roughly equal value to all bidders i.e. value of Yuvraj Singh or Virat Kohli is same for any of the IPL teams, but the bidders don’t know the player’s market value when they bid esp. how he will perform in IPL matches. Each bidder independently estimates the value of the player before bidding. The winner of an auction is the bidder who submits the highest bid. If we assume that the average bid is accurate, then the highest bidder overestimates the player’s value. Thus, the auction’s winner is likely to overpay, also known as winner’s curse.

The term winner’s curse was first coined in 1950’s; during that period there was no accurate method to estimate the potential value of an offshore oil field. For example if an oil field had an actual intrinsic value of $20 million, oil companies might guess its value to be anywhere from $10 million to $30 million. The company who wrongly estimated at $30 million and placed a bid at that level would win the auction, and later find that it was not worth as much- loss of $ 10 million, in other words winner’s curse. In fact average bid was more accurate.

Why leads to overpaying? One of the reason is hubris- excessive arrogance or confidence, which leads a person to believe that he cannot do anything wrong.

Vijay Mallya is known for his flamboyant lifestyle, so it is likely that hubris led to winner’s curse.

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Tragedy of commons, free riders & social loafing.

In game of tragedy of commons, every individual tries to reap the greatest benefit from a given resource (usually a common resource like lake, river etc.). As the demand for the resource overwhelms the supply, every individual who consumes an additional unit directly harms others who can no longer enjoy the benefits.

Examples are not hard to find. During good times, every departmental head tries to expand his team as “resources are badly need to keep business running”, with no regard to its overall impact on manpower plan of organisation, soon there is over staffing esp. if good times are followed by recession or stagnation. Reluctance to downsize means poor bottom line, lesser hike and high attrition.

Pollution of our lakes, rivers, seas, atmosphere etc. are example of tragedy of commons, each industrialist releases untreated effluents, till entire lake/river gets polluted, impacting livelihood of entire population that is dependent on lake/river.

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There is one more phenomenon; it is called social loafing/free riders. Some people try to take advantage of common resource by not paying anything, as others are contributing anyway.
Good example is game of tug of war. Some players refuse to put any efforts, so burden of pulling rope falls on sincere players. Some team players indulge in loafing, as other members will finish the task anyway.

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In Economics, while tax payers’ contribution results in roads, water supply, electricity etc., some free riders ex. slum dwellers enjoy such common benefits free of cost. Soon this pilferage of water/electricity results in bursting of pipes/bringing power gird down- result is entire population suffering.

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Whistle blowing and Volunteer’s dilemma.

I have worked as Ethics Counsellor. The role consists of designing code of ethical conduct, spreading awareness, designing whistle blower policy to encourage employees to report violations and conduct inquiry in cases that get reported and submitting report to board of directors.

Based on my interactions with Ethics counsellors of other companies, in most of the companies very few cases of violation get reported every year.

In game theory there is game called “Volunteer’s dilemma”.

Suppose there is large pothole in a road in your housing complex, which creates problem for your car.

First possibility is you volunteer to fill up that pothole, if you do it, then others too benefit i.e. you bear the cost and they enjoy benefit free of cost.

Second possibility is someone else joins you in this task, now the cost gets shared, but others still enjoy benefit free of cost. In fact had you waited bit longer, the other person would have filled it and you would have benefited from it.

Third possibility is someone else fills it and you enjoy benefit free of cost.

Fourth possibility is no one fills it and in worse situation someone meets with a fatal accident.

Payoff matrix is shown below.

payoff matrix

What volunteer’s dilemma shows is if other person volunteers then benefit to you is maximum, so you always wait for other person to volunteer.

The volunteer also faces other risks ex. Satyendra Dubey from National Highway Authority of India lost his life when he blew whistle to report fraud in highway project, similarly Manjunath from Indian Oil Corporation was killed when he exposed adulterated fuel scam.

Enron and WorldCom had Arthur Andersen as their auditors. As auditors it was their duty to report any financial irregularities, which they did not do. In fact in case of Enron they actively helped their client by destroying all evidence by putting documents in shredding machine. In Enron and WorldCom whistle was blown by their own employees.

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In WorldCom, accountant Cynthia Cooper and her team blew whistle, when she found that operational expenditure was shown as capital expenditure with lower rate of depreciation, and at the same time fictitious sales were shown to increase the revenue. Chief financial officer Scott Sullivan was fired after an it was discovered that transfers from operating expenses to capital accounts amounted to $3 billion in 2001 and $800 million in the first quarter of 2002.This increased cash flow and profit margins, and led to a net loss being reported instead as $1.4 billion profit.

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In case of Enron, Sherron Watkins reported financial irregularities to then CEO of Enron Kenneth Lay, but no action was taken on it. Later financial irregularities led to closure of Enron.

But whistle blowing also resulted in tremendous stress for Cynthia Coopers and Sherron Watkins. They must have face volunteer’s dilemma- volunteer and face problems or wait for someone else to blow whistle.

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Net result was three companies- Arthur Andersen, Enron and WorldCom ceased to exist. Thousands of employees got laid off, many blamed Cynthia and Sherron for this.

Next time if you see few cases of whistle blowing, then volunteer’s dilemma has something to do with it.

whistle blowers

Tall Poppy, Zero Sum Game and Succession Planning

Why does succession planning fail in some organisations? There could be many reasons. But I found two factors play significant role in failure.

They are Tall Poppy syndrome and Zero Sum Game mind-set.

Lucius Tarquinius was king of Rome,  whose his son Sextus Tarquinius captured city of Gabii. After capturing the city Sextus sent a messenger to Lucius, to seek his advice on what to do next. Lucius met messenger in garden, he took stick and moved it across the garden, and this action resulted in cutting off heads of tallest of poppies in the garden. He did not give any verbal or written message to messenger. The messenger told Sextus what he saw. Sextus understood the message and ordered his soldiers to kill all the eminent citizens of Gabii, so that he will not face any opposition in conquered city.

king poppy

This “Tall Poppy Syndrome” exists in many organisations. Where peers and superiors ensure that anyone who is very talented or rising very fast is “cut to size”, to that he/she is no longer threat to them. This syndrome can lead to exodus of talent from organisation, as talented people feel unwanted in organisation.

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In game theory there are zero sum games. A zero sum game is a situation in which one person’s gain is equivalent to another’s loss, so the net change in wealth or benefit is zero. An example of this is game of “matching pennies”.

In this game there are 2 players, say A and B.  They have to simultaneously placing a coin on the table; the payoff depends on whether the sides of coin match or not. If both are heads or tails, Player A wins and keeps Player B’s coin; if they do not match, Player B wins and keeps Player A’s coin. The payoff matrix is shown below. Being zero sum game, one’s gain is other’s loss.

matrix

This zero sum game mind can be extended to organisations. Power is confined to few at top, any addition to this group, results in decline of power of others, since size of power pie is fixed. So entry of new members to privileged club is discouraged. At times it may take form of refusal of CXO to retire (i.e. seek extension or come back as consultant) or refusal to share power with/groom successor.

succession planning

The CEO and board members should find out if “Tall poppy syndrome” and “Zero sum game” mind-sets exist in leadership band, its existence can derail best of succession planning initiatives.

 

In recession, accept bad job offer or wait for good one?

During recession, management graduates if not placed in good organisations face dilemma, should they accept bad job offer or wait for good ones?

If they accept bad job offer, then they are struck with it at least for few months (if they end up signing bond, then many more months). Secondly, in many institutes, if you accept a job, then you are not eligible to apply for another job.

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But remaining unemployed means stress and loss of self-esteem.

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Question is how long should you wait for good job, before taking a bad one?

Game theory offers a solution for making decision in such situations called as backward induction.
As the name suggests, solution is obtained by working backwards.

Let us suppose every month; you can apply for one good job and one bad job. Chances of success are 50% (you are selected for either good job or bad job). If selected for good job, the game ends, but if not selected, you have two options- accept bad job and end unemployment or reject bad offer and try for good job next month.

Mathematical model for decision making works like this.

Suppose you can afford to keep looking for good job for 6 months. Good job offers Rs. 100 per month and bad job offers Rs. 40 per month.

In month 6, value of taking good job is Rs.100, value of taking bad job is Rs. 40, and value of rejecting bad job is Rs.0. It makes sense to take bad job as Rs.40> Rs.0

In month 5, value of good job is Rs. 200 (Rs.100 of month 6 + Rs.100 of month 5), similarly value of bad job Rs. 80. Since there is equal probability of getting either of them, then value of waiting is calculated as 50% of Rs. 100, plus 50% of Rs. 40. i.e. 50+20= Rs.70. Makes sense to take bad job as Rs.80 > Rs. 70

In month 4, value of good job is Rs.300, and value of bad job is Rs.120, while value of waiting is value of offer at month 5, i.e 50% of Rs.200 and 50% of Rs.80, which is 100+40 i.e Rs. 140. Since Rs. 140> Rs. 120, it makes sense to reject bad job and apply for good job in month 5.

So one can keep rejecting bad jobs till month 4, post which accept bad job.

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Fair play and Game Theory

In game theory, there is game called Ultimatum. The game is about how to divide money between two players.

Game is like this- there are two players Player A and Player B. There is certain amount x which has to be divided among themselves.

Player A proposes how to divide the sum between among themselves, and player B can either accept or reject this proposal. If the player B rejects, neither player receives anything. If the player B accepts, the money is split according to the proposal made by player A.

Now in purely economic terms, if amount to be distributed is Rs.100, then split of Rs.99: Rs.1 should be acceptable to B, because if he rejects both he and A get nothing, but if he accepts, he gets least Rs.1.

But when this game was played in real life, the results were surprising. In most of the cases the proposer (first player) offered between 40%-50% to second player, which shows that they wanted to be seen fair in making offer, because unfairness would lead to rejection of offer. On the other hand the second player rejected offer if he was paid less than 30% of amount, as there was element of “honour” attached to it. The second player felt that first player was trying to belittle him by offering him less amount. So results of game are not same in economics and psychology.

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It also has implication for HR manager ex. there is a vacancy in organisation and there are applicants who wish to join organisation, if organisation want to fill vacancy by offering too little to candidate, candidate is likely to reject offer, because he will see it as unfair. Economically it makes sense to take offer, because some salary is better than no salary. But psychology works otherwise.