How Low Can You Go?: Should Auction Reserve Prices Be More Transparent?

All auction houses claim to be transparent, in that anyone can see what is for sale, if it sold and

All auction houses claim to be transparent, in that anyone can see what is for sale, if it sold and exactly how much it sold for. But the transparency to which Mr. Rohan is referring pertains to the “reserve,” the agreed-upon price below which a consignor will not sell an object put up for sale, an amount that is customarily kept secret from bidders but which is made known in advance to those entering a Heritage Auction salesroom. “We’re the only auction house in the world that does this.” He added that the reserve “shouldn’t be a secret. People need to know what it will take to get something they want, and they have time to become comfortable with the amount.”

Items in a sale are given a low-to-high estimate by the auction house. The reserve usually ranges from half the low estimate to 90 percent of the low estimate. (In rare cases, the low estimate will be the reserve, but it will never be above the low estimate.)

The amount of the reserve is often established at the time of a consignment, but it is subject to change, usually downward, generally after the results of similar sales elsewhere reveal low interest in a particular artist. Auction houses often like to be second in holding their sales in order “to have the opportunity to adjust reserves,” said Debra Force, former head of Christie’s American art department and now a gallery owner in Manhattan. “It happens 90 percent of the time. They will see how the first sale goes and then call the owner about lowering the reserve to be safe.”

Ms. Force recently consigned a 1925 George Grosz watercolor to Sotheby’s for its Nov. 7 sale of Modern art, which had a $50,000 to $70,000 estimate and a reserve of $45,000. The day before the sale, she discussed the reserve with staff at Sotheby’s, who suggested that the reserve be lowered to $40,000. To be safe, Ms. Force decided that the amount be even lower, $35,000. However, the lot did not sell.

“Bidders wouldn’t know” that the reserve may have been just lowered, she noted, although they may get a clue by where the auctioneer starts the bidding. For a $50,000 to $70,000 estimated lot, bidding that begins at $30,000 or $35,000 might indicate that the reserve is higher than those that begin at $20,000. Secrecy leads to a guessing game among bidders, experienced and otherwise.

Eliminating this secrecy, she said, does away with what are called in the auction business “chandelier bids”—bidding increases that no potential buyers actually are making in order to raise the bids to the level of the consignor’s reserve price—and that would help people “feel more confident in bidding, knowing that they are competing against other real people.” The market is set by actual bids, rather than amounts an auctioneer claims to read off the ceiling.

If making reserves more transparent sounds logical to Mr. Rohan, it also makes sense to many economists who have studied the auction field. “Secrecy in a market prevents the market mechanisms from working as they should,” said William Baumol, a professor of economics at New York University. Put another way, “secrecy keeps you from knowing you’re paying too much,” said Rachel Campbell, an economics professor at the University of Maastricht (the Netherlands) and an adviser to London’s Fine Art Fund, the premier private equity fund in the art investment field. Paul Milgrom, a professor of economics at Stanford University who has studied the auction field, also claimed that knowing a lot’s reserve price in advance “attracts buyers to auctions,” adding that guesswork leads to mistakes and inefficiencies.”

Kathryn Graddy, a professor of economics at Brandeis University and co-author of a 2003 paper “Auctions and the Price of Art” with Princeton University economics professor Orley Ashenfelter, said that “individuals are reluctant to bid on things when they are uncertain about value. Providing more information, such as the consignor’s bottom line, makes people more confident in bidding. I don’t know of any research that anyone has done that says secret reserves are a good thing.”

Try telling that to most everyone else in the auction field. “Secrecy is very important in getting people to participate in an auction,” said Peter Loughrey, president of Los Angeles Modern Auctions. “People will participate if they don’t know the reserve. They think, ‘Say, I’ll go after it, but, as soon as you tell people the reserve, they think, ‘I can’t afford it,’ and won’t consider going after the piece.”

An auction, seen this way, is an exercise in manipulating individual and even group psychology, with the reserve at its very center. “People who think they can’t afford the reserve won’t come to the auction,” Mr. Loughrey said. “Without participation, you don’t get things sold. The more participation, the more people believe there is a strong market.” The more people participate, the more “competitiveness pushes people higher in their bids.”

Chicago auctioneer Leslie Hindman defended secrecy on the grounds that not revealing the reserve thwarts buyers—dealers, often—who might form “rings” or “pools,” working in collusion to keep prices lower than they might go otherwise or even to keep lots from selling at all. “I do think that people would be able to pool more aggressively in certain collecting categories if reserves were known.” 

The larger auction houses take the same stance. Jonathan Olsoff, senior vice president and worldwide director of litigation for Sotheby’s, claimed that secret reserves do not deter bidding and, without secrecy about the seller’s bottom line, “there would not be any incentive for any of the bidders to enter an opening bid, in the hope that the property will not be sold at auction. This would, in turn, provide potential buyers with the opportunity to seek to negotiate a private sale with the seller but with the advantage of knowing the minimum price that the seller is willing to accept.” He added that an “auction is, in some ways, a negotiation, and in what negotiation does someone say, ‘I want this price, but here is the minimum I will take’? Think of selling a house. You wouldn’t do that, because you would disadvantage yourself.”

A spokesman for Christie’s commented that revealing the reserve would tend to level the playing field and, thereby, keep prices lower. “If you’re playing poker, why would you put your cards down for everyone to see?”

Mr. Rohan countered these claims by asserting that “hidden reserves tend to trap neophytes into making unwise purchases, giving experts an advantage over nonexperts,” since dealers and experienced collectors will have a better sense of value and be able to ascertain the reserve based on the estimate. He also thought that worries about groups of dealers colluding to hold down prices is overplayed. “To us, the notion that hidden reserves reduce ‘pooling’ never made sense,” he said. “And it seems even more illogical today” with the globalization of the collectibles market and the opportunities for people to make bids online.

If the secrecy of the reserve has a questionable effect on the sale and final price, the amount of the reserve has a strong role,” Ms. Graddy claimed. “Very low reserves make sales more likely.”   

How Low Can You Go?: Should Auction Reserve Prices Be More Transparent?