Responsibility for Cost Management Hinders Learning to Avoid the Winner's Curse

Abstract

Errors in estimated product costs often lead firms to win business that is unprofitable, because firms are more likely to win business when underestimated product costs lead them to bid below actual cost (Cooper et al. 1992; Stalk and Lachenauer 2004; Hilton 2005). Feedback from repeated competitive bidding markets can teach people to bid well above estimated costs to avoid this winners' curse (Kagel 1995; Kagel and Levin 2002). We present experimental evidence that such learning is substantially hampered by managers' sense of responsibility for the costs. We hypothesize and find that, compared to bidders who are assigned cost-management initiatives for the firms they control, bidders who select their own initiatives bid more aggressively, lose more money, and learn less from market experience than bidders who are not responsible for choosing cost-management initiatives. This effect is consistent with psychological evidence that people tend to attribute bad outcomes to environmental factors out of their control, such as cost estimation errors, and attribute good outcomes to their own skills, such as their ability to choose effective cost management initiatives (Miller and Ross 1975; Zuckerman 1979). The results suggest that there are benefits to separating responsibilities for cost management and pricing in firms where accurate cost estimation is difficult.

Keywords: Winner's curse, auctions, behavioral economics, cost accounting, laboratory experiment

JEL Classification: D44, C92, M40, M46