Auction Institutional Design: Theory and Behavior of Simultaneous Multiple Unit Generalizations of the Dutch and English Auctions

Historically, English and Dutch auctions have been used for the exchange of single objects such as works of art or single lots of a good such as produce, fish, or cut flowers. Where these institutions have been used for the exchange of multiple units, such as the Australian wool auction (using English rules), successive lots of the good are sometimes sold sequentially at auction. In some, but not all, instances this is because the goods are not identical, even though the various lots may be close substitutes (see Penny Burns, 1985). Where the goods are accepted universally as being homogeneous, as in the securities markets, multiple units are often commonly auctioned simultaneously. In the securities industry, orders are batched for simultaneous execution in multiple-unit auctions in what are referred to as "call markets"; that is, the security is "called" for auction at a particular point in time. This type of market is used on the stock exchanges of Austria, Belgium, France, Germany, and Israel. Some of these are verbal, and some are sealed bid auctions. Although the U.S. organized exchanges are predominantly continuous rather than call markets (except that call markets are used each day to open trading in each listed security), there is a growing number of exceptions such as the proliferation, since 1984, of Auction Preferred Stock (Goldman, Sachs and Co., October 1984) and Money Market Preferred Stock (Lehman Brothers, July 1984). We now have Dutch Auction Rate Transferable Securities, called DARTS, Stated Rate Auction Preferred Stock, or STRAPS, and many more. After the initial subscription offering of this type of security, the market is called every 49 days to reset the preferred dividend rate using a multiple-unit auction. The exchange of shares and the dividend determination is based on the array of stated dividend rates at which existing holders and potential new holders are willing to sell and/or buy corresponding quantities. The dividend rate and exchange of shares every 49 days is executed using the uniform price or competitive sealed bid mechanism (Vernon L. Smith et al., 1980). The discussion to follow will be confined to this sealed bid form of the call market. Call markets provide temporal consolidation of trade orders or other forms of expressing the desire to buy and sell. By comparison with continuous trading, call markets offer both advantages and disadvantages (Robert A. Schwartz, 1988 pp. 442-6). The cited advantages include low cost of operating the exchange; information aggregation and presumed pricing efficiency; price stability; individual trades, which are thought to have a small impact on price; reduced price uncertainty; and, finally, nondiscriminatory pricing. However, there are offsetting disadvantages: (1) the market is inaccessible except at the time of call; (2) no bid, offer, contract, or price information is available until the results of the call are announced; and (3) there is transaction uncertainty because a submitted bid (offer) may be too low (high) to execute inside the supply-demand cross. These conditions are only partially alleviated if there is a secondary market between calls. These disadvantages may be significant. In September 1988, the Wall Street Journal published an article on the failure of a call market for the auction rate preferred stock *Economic Science Laboratory, University of Arizona, Tucson, Arizona. This material is based upon work supported by the National Science Foundation under grant no. SES-8320121.