Commitment & Loss aversion

On the first day of class, Professor Bazerman announces a game that seems innocuous enough. Waving a twenty-dollar bill in the air, he offers it up for auction.

Everybody is free to bid; there are only two rules. The first is that bids are to be made in $1 increments. The second rule is a little trickier. The winner of the auction, of course, wins the bill. But the runner-up must still honor his or her bid, while receiving nothing in return. In other words, this is a situation where second best finishes last.

Indeed, at the beginning of the auction, as people sniff out an opportunity to get a $20 bill for a bargain, the hands quickly shoot up, and the auction is officially under way. A flurry of bids follows. As Bazerman described it, “The pat tern is always the same. The bidding starts out fast and furi ous until it reaches the $12 to $16 range.”

At this point, it becomes clear to each of the participants that he or she isn’t the only one with the brilliant idea of winning the twenty bucks for cheap. There is a collective hard swallow. As if sensing the floodwaters rising, the stu dents get jittery. “Everyone except the two highest bidders drops out of the auction,” Bazerman explained.

Without realizing it, the two students with the highest bids get locked in. “One bidder has bid $16 and the other has bid $17,” Bazerman said. “The $16 bidder must either bid $18 or suffer a $16 loss.” Up to this point the students were looking to make a quick dollar; now neither one wants to be the sucker who paid good money for nothing. This is when the students adopt the equivalent of football’s war-of -attrition model. They become committed to the strategy of playing not to lose.

Like a runaway train, the auction continues, with the bid ding going up past $18, $19, and $20. As the price climbs higher, the other students don’t know whether to watch or cover their eyes. “Of course,” reflected Bazerman, “the rest of the group roars with laughter when the bidding goes over $20.”

From a rational perspective, the obvious decision would be for the bidders to accept their losses and stop the auction be fore it spins even further out of control. But that’s easier said than done. Students are pulled by both the momentum of the auction and the looming loss if they back down-a loss that is growing greater by the bid. The two forces, in turn, feed off each other: commitment to a chosen path inspires additional bids, driving the price up, making the potential loss loom even larger.

And so students continue bidding: $21, $22, $23, $50, $100, up to a record $204. Over the years that Bazerman has conducted the experiment, he has never lost a penny (he donates all proceeds to charity). Regardless of who the bidders have been-college students or business executives attend ing a seminar-they are always swayed.

The deeper the hole they dig themselves into, the more they continue to dig.”

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