The Wall Street Journal

June 7, 2004









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Google IPO
Tests Theories
On Auctions

June 7, 2004; Page C1

Let the game begin.

As large and small investors gear up for Google Inc.'s $2.7 billion initial public offering of shares, an obscure group of academic thinkers known as auction theorists are already trying to figure out the best way to get a piece of the action.

The Internet-search engine's plan to go public through an auction has captured the attention of these researchers, who analyze bidding mechanics. That means they anticipate how bidders will behave, how much they are likely to pony up and whether winners pay too much for their prize.

Legg Mason portfolio manager Bill Miller, who is considering bidding for Google shares in the IPO, has consulted with two auction theorists. Students of auction theory in California and New York are evaluating Google as a case study. And last month, even Google consulted with one of the country's best-known auction theorists -- essentially oddsmakers who analyze the best strategies for making a winning bid.

"I'm becoming very popular," says Matthew Rhodes-Kropf, who specializes in auction theory at Columbia University's business school in New York and is fielding questions from family members and friends who are potential Google investors.

Under the system outlined so far by Google, investors will register with investment banks underwriting the offering, indicating how many shares they want to buy and the price they are willing to pay. Google and its bankers will consider the bids and other factors to determine a "clearing price" at which all of the bids could be sold. Anyone bidding below the clearing price won't get any shares. Google, which hasn't set a date for the IPO yet, is expected to release more details in coming weeks and months.



 Street Sleuth: Valuing Google Shares1






A Google spokeswoman declined to comment.

Auction theory is related to the serious study of games in which researchers use economics, mathematics and psychology to assess the way people make decisions. And they aren't just finding ways to win at poker: Game theory has been used to study financial markets, war strategies and airport-landing fees.

Auction theory, too, is playing a role in big business. In 1994, auction theorists from Stanford University in California helped the Federal Communications Commission set up rules for an auction to sell wireless spectrum. Telecommunications companies, which were bidding for the spectrum, hired the logicians to guide them through the hotly contested sale of wireless frequencies that eventually raised more than $20 billion. Energy companies have consulted with auction theorists when bidding on foreign oil leases. In 1996, Columbia University's William Vickrey won the Nobel Prize in economics for his research on auctions.

Auction theorists find Google intriguing because so many individual investors are expected to bid on the shares. By pursuing an auction, Google is shunning the traditional IPO model in which professional investors buy most of the newly issued stock. Although other companies have gone public through a similar auction process, the Google IPO will be the largest by far.

A pool of bidders that includes professionals and mom-and-pop investors alike means there is more of a chance that some of them will bid too high, say auction theorists. Furthermore, individual investors are unlikely to use the same criteria to analyze Google's value as professional investors, they say. Another wrinkle: Different investors are bound to have different views of Google's value depending on how long they plan to own the shares.

"It's an unusual situation," says Paul Milgrom, a Stanford auction theorist who recently met with Google executives to discuss the auction process. He declined to comment specifically on the meeting, citing a confidentiality agreement.

Indeed, these are some of the issues that drove Mr. Miller, who oversees about $36 billion in assets under management at Legg Mason, to discuss Google with auction theorists. "I wanted to understand if there was anything in the theory of auctions that could explain the kinks that can arise that could affect how you might bid," he says.

Like most auctions, one of the biggest risks facing Google investors is what is known as "the winner's curse," an outcome in which a bidder triumphs by overpaying.

"We only have bits of auction theory about how people behave in these situations, so this is a unique opportunity in that sense -- it's a $3 billion experiment," says John Miller, an economics professor in the department of social and decision sciences at Carnegie Mellon University in Pittsburgh.

Because the pool of bidders is likely to be large, auction theorists say it will be difficult -- and potentially risky -- for investors to game the Google auction by making an offer based on mere beliefs about what others will bid. "The best strategy in this type of auction is to bid the truth because you want to put in a bid at a price where, if you win, you don't suddenly say, 'Oops,' " says Mr. Rhodes-Kropf.

And that's exactly what the Columbia professor plans to do when he places his own bid for Google shares. "I don't think of this as some great opportunity to make a killing off my own information, but since I happen to study financial-auction theory, how can I not bid?" he says.

Write to Robin Sidel at robin.sidel@wsj.com2


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