Auction markets for evaluations.

• Author: Deck, Cary A.

1. Introduction

   As the technology of electronic exchange advances, new opportunities emerge for developing markets for products and services whose innate properties hamper efforts to do so in traditional settings. Even though one such good, product evaluations, has been long used for durable and nondurable goods alike, the transaction costs associated with providing and disseminating product evaluations have limited the scope of their use. Historically, evaluations have been limited to "word of mouth" exchanges among acquaintances and the reports of paid critics. (1) The Internet not only has the potential to significantly reduce the transaction costs for evaluation sharing, but it can also significantly reduce the costs for forming a centralized market mechanism to allocate evaluations. Although numerous evaluations are currently freely available on the Internet for everything from CDs and books to articles and professors, these services are incomplete. (2) For example, Amazon.com provides free book reviews by other customers who voluntarily provided the review, but there are numerous books that have not been reviewed. Ratemyprofessors.com enables students to share evaluations of their college instructors, but not every teacher has been rated. A market for evaluations creates the incentives for individuals to provide evaluations that might otherwise not be provided.

   Avery, Resnick, and Zeckhauser (1999) provide a first step in creating a pricing mechanism to induce the efficient provision of evaluations. They discuss how, without a market for evaluations, risk neutral agents will provide a suboptimal level of evaluations because consumption is nonrivalrous (3) and because one person's experience might not perfectly predict another's outcome. The nonrivalrous nature of evaluations could also result in an inefficient ordering of the evaluators themselves, if the potential evaluators have heterogeneous opportunity costs for producing an evaluation. The optimal quantity can also depend on what the early evaluations reveal about the value of the product.

   Avery, Resnick, and Zeckhauser (1999) show that a market mechanism can be used to solve these various social problems. They consider both sequential and batch evaluation games and demonstrate that a centralized broker who knows the pool of values and opportunity costs for the players can set a price for providing and receiving information so as to eliminate the social inefficiency. This paper relaxes the assumption that a central broker holds all of the pertinent information, which, as a point of practicality, would not hold in an actual implementation of such a mechanism. Using the experimental method, we study how efficiently four different market mechanisms voluntarily elicit an evaluation in exchange for payment, without any centralized information about the pool of values. This subjects the market mechanisms to the challenging task of inducing the optimal person to voluntarily provide a nonrivalrous evaluation. As an initial foray into implementing a market for evaluations, we consider variations of and then compare the efficiency and prices for uniform price sealed bid, discriminatory price sealed bid, English clock auction, and Dutch clock auction.

   We follow Avery, Resnick, and Zeckhauser (1999) in considering a framework in which people have already made the decision to enter a product market. As a simplifying assumption for this exploratory research, the individuals in the markets have identical tastes for whether a product is "good" or "bad" and the same ability to discern those tastes. Individuals, however, differ in their values for a "good" or "bad" product. Thus, unlike Avery, Resnick, and Zeckhauser (1999), a single evaluation perfectly reveals whether the product is "good" or "bad." This assumption eliminates the inefficient ordering and optimal quantity problems and makes the underprovision problem binary, thereby allowing us to focus on the crucial issue of how the mechanisms aggregate private information, determine prices, and affect efficiency.

   In our controlled test, we find that the provision of evaluations is markedly inefficient without a market mechanism, but not nearly as inefficient as what is predicted. Additionally, we find that each of the four mechanisms succeeds at increasing market efficiency by encouraging the socially optimal agent to undertake the costly evaluation when no one else is willing to do so. Finally, we observe that the four mechanisms are behaviorally equivalent with respect to the prices received by the evaluator. The structure of the paper is as follows. Section 2 presents the experimental design that we consider, and section 3 outlines the treatments and procedures. Section 4 discusses our results, and section 5 briefly concludes.

2. Experimental Design

   Suppose there are two identical risk-neutral individuals considering reading a book. A particular book could be "good," resulting in a payoff of g > 0, or "bad," resulting in a payoff of b < 0 with [absolute value of b] > [absolute value of g]. If each outcome is equally likely, then both individuals have a negative expected value for reading the book and hence should opt for their next best alternative, provided that alternative payoff c is greater than (g + b)/2. However, it is not necessarily socially optimal for neither person to read the book. Consider the case in which one individual decides to read the book and then provides an evaluation to the other person. In this case, the evaluator expects to receive (g + b)/2, but the person receiving the evaluation can make a more informed decision. This informed person will read the book if it is "good" and receive a payoff of g. However, if the evaluator reports that the book is "bad," the other person will not read it, choosing the opportunity cost c over the bad payoff b. Hence the person receiving the evaluation has an expected payoff of (g + c)/2, and the social payoff from one person evaluating the book is [(g + b)/2] + [(g + c)/2], which is greater than 2c so long as c < (2g + b)/3.

   The solution to this social problem lies with the creation of a market that allows one potential consumer to compensate another for undertaking the costly evaluation. Avery, Resnick, and Zeckhauser (1999) present a formal treatment of this problem and demonstrate the existence of an equilibrium price that attains the socially efficient outcome. (4) This price is paid to the evaluator by the person waiting to make an informed decision. In the example presented above, the unique equilibrium price, P, is (c - b)/4. This price is found by equating the expected payoff of the evaluator to the expected payoff of the person who waits, or P insures that (g + b)/2 + P = (g + c)/2 - P, thereby making the two identical people indifferent between evaluating and waiting.

   Institutions

   Equipped with the theoretical foundation that a market can solve this problem, the next step is to identify what market institutions should be implemented in practice. The identification of the market price in the preceding paragraph requires collective knowledge of three pieces of information for each individual i, namely [g.sub.i], [b.sub.i], and [c.sub.i], plus the probabilities that the product or service is "'good" or "bad." In practice, these pieces of information are typically private and unobservable (or unverifiable). Thus, one role of a functioning market is to aggregate private information and coordinate behavior. Therefore, any market institution must determine (i) who will be the evaluator and (ii) the price paid or received by each agent. As discussed in Smith (1994) the institution can significantly influence behavior and therefore market outcomes. For example, the four most common types of private value auctions, uniform price sealed bid, discriminatory price sealed bid, English clock, and Dutch clock, are all theoretically revenue equivalent under certain assumptions; yet, there is widespread evidence from the laboratory that these distinct formats elicit different behaviors, which affect market performance. (5) This paper takes the next step toward constructing markets for evaluations by developing variants of these four well-known market institutions and comparing the performance of each. An important distinction between our environment and that of the standard private value auction is that the evaluation is nonrivalrous. (6) Within the controlled confines of the laboratory, these wind tunnel tests directly compare these institutions to each other, as well as to a baseline case in which no market exists.

   No-market Baseline

   In the baseline case, a fictitious product is available for evaluation for a limited time, T. If at any point during this time one of the n individuals consumes and evaluates the product, then the payoff state, good or bad, is revealed to everyone. As a simplification, if the product is good, then everyone who waits receives their own good payoff [g.sub.i], but if the product is bad, all of the people who wait receive their opportunity cost el. The evaluator also receives [g.sub.i] if the product is good, but when it is bad, the evaluator receives [b.sub.i]. In this situation, the dominant strategy is to wait and see whether the others evaluate, regardless of how much time is remaining, assuming that the opportunity cost is sufficiently high. Formally, let [[lambda].sub.i] denote a player i's belief about the probability someone else will evaluate during the remaining time. The expected payoff to waiting is [[lambda].sub.i]([g.sub.i] + [c.sub.i])/2 + (1 - [[lambda].sub.i])[c.sub.i], which is greater than ([g.sub.i] + [b.sub.i])/2, the expected value of evaluating, if [[lambda].sub.i] > 1 + ([b.sub.i] - [c.sub.i])/([g.sub.i] - [c.sub.i]). This condition is equivalent to [[lambda].sub.i] [greater than or equal to] 0 if [c.sub.i] > ([g.sub.i] + [b.sub.i])/2. We now describe four distinct institutions for providing an...