Transaction Costs, Participation, and the Cost-Effectiveness of Reverse Auctions: Evidence from a Laboratory Experiment

Abstract Reverse auctions are often recognized as a tool that can cost-effectively allocate agri-environmental program funds to support environmentally-beneficial land management practices. However, transaction costs can limit participation in auctions which limits their cost-effectiveness. We use a laboratory experiment to examine how various levels of transaction costs influence participation and bidding behavior in discriminatory-price reverse auctions in low and high budget scenarios. Our experimental results show that transaction costs limit auction participation, increase bid amounts, and reduce cost-effectiveness. The negative effect of transaction costs on participation is particularly large when the budget level is low. Using the results of our experiment, we design a simulation to investigate whether reducing transaction costs via subsidies could increase program cost-effectiveness under various conditions. We find that transaction cost subsidies increase auction cost-effectiveness; however, our study raises new questions about how these subsidies are designed and the implications for the overall costs and benefits of efforts to reduce transaction costs in reverse auctions.