The winner's curse is the tendency for individuals to overbid in common value auctions when information between buyers and sellers is not complete. If you are bidding in an auction with many others for an asset that you don’t know the value of, a winning bid can be overly optimistic and it can exceed the intrinsic value of the asset purchased. Simply put, if you win an auction when you don't really know what something is worth, there’s a chance you’ll be had! This curse has been shown to even affect experienced bidders.
This curse was originally conceptualized in light of auctions for oil reserves in the Mexican Gulf and famous experiments by William Samuelson and Max Bazerman during the 1980’s showed how buyers in the lab consistently fail to appreciate their information disadvantage when formulating a bid in bargaining games. When the best strategy to take is to opt out, the temptation to bid is too much for some.
Economists have since looked to sport as a means to test for the winner's curse in the field. The big advantage of sport is that it provides scope for productivity evaluations that other auctions do not. We can tell how well an asset has performed after they are purchased, in this case a sports star.
In particular, economists have looked toward baseball. The original study on the topic was by James Cassing and Richard Douglas. In 1980 the researchers analysed the bidding strategies of potential buyers of free agents in Major League Baseball, as naturally each franchise would place a different value on what a free agent is worth. The researchers found that from 1975 to 1980 free agents were overpaid relative to their productivity. A second study that cited the winner's curse was written in 1993 by Lawrence Kahn. While his research did not specifically set out to address the curse, Kahn ended up explaining his results in light of it. His study looked at salary and contract length for virtually all Major League Baseball players from 1987 to 1990. The winner's curse or 'super competitive' bidding was found again. The most recent study comes from 2008 by John Burger and Stephen Walters who revise downward the strength of Cassing and Douglas’ (1980) original findings. Using superior measures of productivity to gauge player performance, they argue that there was positive returns to free agency over the late 1970’s and also the 1990’s. They suggest a ‘weak-form’ version of the winner's curse exists as the full expectations of buyers may still not be met.
More information is often suggested as a solution to this curse but given that status and buying superstars for commercial purposes seems to be important across sports, it may always be the case that owners are not particularly concerned about efficiency or rational bids. Bounded rationality with a boosted ego may do just fine!