Sophisticated Tactics of the Mysterious Circle

or

Fairness and Disclosure in Auction Sales

By

Ryuhei Mogi

One may view on television reports of record prices for Impressionist paintings or see films in which the setting of an art auction appears as a symbol of the high life of its characters. Perhaps an auctioneer is calling repeatedly ascending amounts in a very speedy manner. Then, at some moment, he declares "Knocked down" and an art object on the stand is removed. When some very rich man wins a bid for an important object at a record price and he or his agent receive loud applause from the gallery on the auction floor, you can recognize the final winner. However, in many cases, it is difficult to identify the final winner or even to find whether the object has actually been sold or not. In fact, nobody really knows who is bidding and for what prices during the bidding process, except one person - the auctioneer.

The bidding process thus described is known as the English method. Under the English method, the auctioneer solicits successively higher bids by calling out the current bid price that some bidder is asked to meet. The auctioneer may, at his discretion, decide how much of an increase to make when he calls out the next bid.

There are several alternatives to the English auction. The two other major methods are the Dutch auction and the Japanese auction. Under the Dutch method, bidding starts at a very high price and descends incrementally. At some point during these descending prices, a bidder accepts the price and he wins the bid for the object. The Japanese method is ascending bid like the English method. In a Japanese auction, bidding begins at a low price and those bidders who have interest in the object express their interest by raising their hands or by some other means. Then the bidding increases by a fixed amount. At each bidding stage, bidders who are not willing to pay the increased price drop from the bidding process. The last bidder who survives the process will win.

In art auction practices, not only in England and the US but also in other countries, the English auction method is overwhelmingly prevalent. In fact, although Japan gave the Japanese auction its name, even in Japan, recently, most art auctions are conducted by the English auction method.

Several reasons may explain the popularity of the English method. One reason is its exciting atmosphere. The speedy and rhythmical call of increasing prices by the auctioneer and the competition among bidders in this rapid process is exciting. People attending love the excitement. However, the most powerful explanation may be that, under the English method, the auctioneers have so much power to control the bidding process and may use that power to raise the sale price. Auction houses may prefer the English method due to the power it gives to auctioneers. Sellers also welcome this method because they may fetch higher prices.

Under the English method, the auctioneer sets the bidding price increase. In addition, the auctioneer may raise the bid price even if he does not recognize any bid from the auction floor. First, it is not illegal for an auctioneer to make a bid on behalf of the seller, as long as the bidding price does not exceed the reserve price set by the seller. Therefore, auctioneer may increase the bid price until such price reaches the reserve price, regardless of whether any bids are made from the floor. Such a bid is called a "chandelier bid". Second, the auctioneer may bid on behalf of an order bid (a bid made in advance by those bidders who cannot attend the auction and give authority to the auction house to bid on their behalf up to a certain maximum amount). Therefore, the auctioneer may raise the bid price until the price reaches the maximum set by the order bid. Furthermore, as many professional bidders make their bidding through signals (e.g., pulling a handkerchief out of a pocket) recognized only by the auctioneer, other bidders can not know whether the bid price announced by the auctioneer is based upon a bid on behalf of the seller or an order bidder or an actual bid from the auction floor. As a result, the auctioneer, the only person who has authority to set the bidding price increase and the only person with all the information on the bidding process, may stimulate the floor and excite the bidders by various strategies. He may change the pace of the increase or intervene in the process with a bid on behalf of the seller or an order bidder in order to maximize the final sale price. He may also cover the failure of a sale at auction when the highest bid price does not reach the reserve price.

Some dealers (in many cases, they are bidders) or commentators criticize such practices as improperly inflating prices over the proper market price. While such practice is not illegal, I believe, such practices are unfair or at least appear to be unfair to the actual bidders. Given the fact that auction houses receive premiums from buyers as well as commission from sellers, auctioneers should act primarily as neutral middleman. However, in fact, auctioneers concentrate their efforts on raising the sale price, benefiting only the sellers. Such practice seems to be unfair to buyers. In addition, even if auction houses claim that they do not commit any improper practices, bidders may not be fully persuaded where they can obtain only scarce information.

In light of such problems in practice with the English method, I believe some reform is necessary and some other method should be considered. The purpose of such reform is (1) to limit the role of auctioneer to the role of judge or referee and (2) to make the bidding process open.

The application of the Dutch method to art auctions, however, is impractical. First, under this method, it is difficult to determine the winner when two or more people bid simultaneously. Although several measures are applied to resolve this problem in a Dutch auction, these measures are only appropriate where quantities of the same kind of objects (such as tulips) are sold at auction and where sharing of the objects is possible among the bidders. Therefore, such measures do not fit for art auctions where unique objects are sold. Second, under the Dutch method, the entertainment feature associated with art auctions is lost. Under this method, the first bidder wins, therefore no competition among bidders is visible. The period of declining prices is simply a dead silence. Nobody involved in art auctions, including the bidders, would want to accept such uninteresting bidding.

On the other hand, the Japanese method can resolve the problems with the English method without losing the basic charm of the art auction. First, under the Japanese method, the rules for the bidding process are formalized and the role of auctioneers is limited to the role of judge. Auctioneers raise the bid price only by a pre-determined amount. They raise the bid price only after they confirm that two or more bidders remain. Auctioneers only administer the process in accordance with the rules and check whether the process is accord with such rules. Auctioneers are neutral judges or referees. They do not take the part of either the sellers or the buyers. In addition, the process is open to all attending. It is visible and clear for the audience who are bidding at specific amounts and who is the final bidder. Under such a method, it is clear that auctioneers cannot commit the improper practices that are suspect under the English method. In addition, as the bidders can watch the bidding process, they do not doubt the propriety of the process. Furthermore, a Japanese auction does not lose the charm of the art auction, as the competition among the bidders is more visible than in the English method. It is true that the Japanese method may delay the process to some extent. However, while many bidders remain, the auctioneer may expedite the process by raising the price rapidly. Anyway, just raising or lowering the hands of bidders to indicate their intentions will not take so much time.

The Japanese method is a fairer and more open bidding process than the English method. It is also maintains the basic charm of the English method of art auction. Therefore, I believe that adopting the Japanese method instead of the English method is the proper choice for the future of the art auction. To adopt this method, some regulation is necessary, because the auction houses will never adopt a system that reduces the power of the auctioneer without regulations.

Some may miss the mysterious atmosphere of an English -style auction, where auctioneer and professional bidders use various strategies or techniques. However, the art auction is no longer a closed place limited to fashionable society. It should be recognized that the art auction is primarily a market place and that practices should be implemented in accordance with the principles of fairness and disclosure commonly applied to any market behaviors.