How Does a Dutch Auction Work?

A Dutch auction differs from a regular auction in that it opens with a high asking price, instead of a low one. Many nations’ treasury departments, including the U.S. Treasury, use Dutch auctions to sell securities. Dutch auctions are also popular alternative bidding processes to initial public offerings, or IPOs.

Meaning and Purpose of Dutch Auction

In a Dutch auction, the price of an item is typically set at a very high price – higher than what most customers will pay – and the auctioneer lowers the price until someone bids on the item. When the event is a Dutch auction IPO, prospective investors bid on both the price and quantity of shares. The purpose of this type of auction is to sell all shares at once, even if it’s to different bidders.

Bidding Process

The Dutch auction usually begins with a company revealing the amount of shares for sale, as well as a potential price for the shares. At the auction, which normally occurs online, the auctioneer calls out the first, high bid. When there are no responses, the price is lowered continually until the first person places a bid. That person is the winner of the bidding.

In other types of Dutch auctions, especially IPO auctions, the process may be longer, due to the necessity of selling all the stocks. For example, a company may have 5,000 stocks for sale, and the first bidder only places a bid of $50 for 100 shares. The bidding continues until all 5,000 stocks are bid on. If the last bidder only bid $20 per share, then that is what all the bidders will pay for their allotted number of bid-upon stocks. So, the first bidder will only pay $20 for the 100 shares on which he bid.

Differences Between Traditional and Dutch Auctions

The bidding price at a Dutch auction decreases throughout the process, the opposite of traditional auctions. Traditional auctions, sometimes referred to as English auctions, begin with a set low price. The auctioneer slowly raises the price until bidders stop placing bids. The last bid-upon price is the winning bid.

Benefits of a Dutch Auction

In the investment world, using a Dutch auction for IPO allocation can benefit young companies, as it can allow the business to raise the most amount of cash available in the market. Shareholders of companies that are in high demand can make high profits very quickly. It also benefits investors who get a jump on their competitors and bid first, but are then given the opportunity to take advantage of lower share pricing.