Dutch auction is primarily a kind of auction wherein the price on a particular item is lowered till the time it attracts a bid. The bid that is made first is considered to be the winning bid and transforms into a sale, on the assumption that the bidding price is more than the reserve price. In this sort of an auction, the investors bid for an amount that they are willing to pay for buying, both in terms of price and quantity.
Dutch Auction is essentially a method that is used for valuing shares (often in IPO). In such a case, the share price is lowered till the time sufficient number of bids for selling the shares is received. The shares are eventually sold at that particular price.
For example, if a company uses a Dutch Auction IPO and an investor places bid for hundred shares at the price of $100 whereas another investor places a bid for $95 for five hundred shares, then once the entire bids have been submitted, the shares starting from the highest bidder to the lowest one, till the time all the shares have been assigned. But the price paid by each bidder is fixed as per the lowest price of the entire allotted bidders or the last bid that was successful. Thus, even if you have bid 100 dollars for acquiring one thousand shares and if the last successful bidding was valued at eighty dollars, then you would have to pay only eight dollars for the thousand shares.
Why Dutch Auction Matters?
Usually the share prices in an initial public offering is decided by the investment bank only after it has successfully conducted numerous calculations pertaining to valuations and has also talked with the interested investors. However, the Dutch Auction method is considered to be far more reliable and efficient in terms of determining the ‘correct’ price, which equates demand and supply.
Those supporting the method suggest that the smaller investors can easily access initial public offerings since in the traditional process of offering the investment banks often funnel IPO shares to the best of their clients who in turn make quick gains (in case the prices of stock rise). However, some experts believe that investors pay more for shares sold as part of Dutch Auctions since in the traditional method, the investment banks usually underprice the shares to ensure that all the shares sell.