Abstract
We combine theory and empirics to (i) show that some buyers in online advertising markets are financially constrained and (ii) demonstrate how to design auctions that take into account such financial constraints. We use data from a field experiment where reserve prices were randomized on Google’s advertising exchange (AdX). We find that, contrary to the predictions of classical auction theory, a significant set of buyers lowers their bids when reserve prices go up. We show that this behavior can be explained if we assume buyers have constraints on their minimum return on investment (ROI). We proceed to design auctions for ROI-constrained buyers. We show that optimal auctions for symmetric ROI-constrained buyers are either second-price auctions with reduced reserve prices or subsidized second-price auctions. For asymmetric buyers, the optimal auction involves a modification of virtual values. Going back to the data, we show that using ROI-aware optimal auctions can lead to large revenue gains and large welfare gains for buyers.
Highlights
We show that in practice many buyers lower their bids in response to higher reserve prices! While such shading behavior is inconsistent with quasilinear utilities, we show in Theorem 3.1 that this is in accordance with equilibrium behavior under financial constraints
With this formulation in mind, we propose a framework where buyers require a certain return on investment (ROI) in order to participate in the system
As we show in Theorem 5.5, the optimal auction for ROI-constrained buyers can be interpreted in terms of modified virtual values, where the modification is designed to make a buyer’s ROI constraint binding when appropriate
Summary
A key feature that makes second-price auctions so appealing to both market designers and market participants (buyers) is that they are truthful That is, it is a dominant strategy for buyers to report their true valuations as their bids. A more standard business approach to modeling financial constraints is to assume that firms see online ads as one of several available investment opportunities and that they avail themselves of the investments that generate the highest returns. With this formulation in mind, we propose a framework where buyers require a certain return on investment (ROI) in order to participate in the system. Using an ROI-aware auction increases revenues and increases the welfare of the buyers
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