The winner's curse, though it sounds like a very negative thing, is actually fairly simple to explain and to avoid. A winner's curse occurs during an auction. Such an auction could be held for a single item, or for a company or it could refer to bids placed to obtain something like advertising space.
The item upon which a bid is placed will have the same value to any person who wins the auction; so the auction is often called a common value auction. When a person bids higher than the actual value, he or she may win the auction, but also invokes the winner’s curse. In other words, he or she pays more than the actual value. If the person exceeds the actual value of the item, then he or she has won the item but lost financially.
Many times the winner's curse occurs when bidders have insufficient information about the real value of an item. If a potentially profitable stock is offered in an initial public offering (IPO), it's hard to gauge whether the business will ultimately raise the value of the stock beyond the purchase price. When inflated prices or bids for IPO stock are common, and if the company does not do well financially, then the winner's curse is invoked. The winning bidder loses if the stock doesn't make money because he or she has overestimated the value of the IPO stock.
In any type of auction, even for small items, bidding can get hot. Numerous eBay bidders have won auctions only to find that the shipping costs or the cost they will pay for the item exceeds its value. Thus they both win and lose.
Even in silent auctions or standard auctions, the winner's curse can occur when people may pay much more to “win” something at a financial loss. To some people this isn’t necessarily a loss. If an auction takes place to raise money for a reputable charity, overpaying for an item is compensated by the fact that the person did benefit a charity. It’s something of a win-lose-win situation. The charity wins, you win the auction, but you lose slightly because you paid more than an item’s actual worth. This is quite common, especially when bidding becomes competitive and even if the people bidding are aware of the item’s value.
You can avoid a winner's curse by keeping bidding for any item or thing within its known value. It’s important to stay calm when bidding, and keep an eye to not only winning the auction, but also doing so without losing money in the process. This can be more difficult than people think, because “winning” can become the first objective, instead of getting a good deal.