Abstract
We study whether the presence of a negative externality in an all-pay auction affects players' behavior in the laboratory. Based on a model with risk-neutral preferences it should not, as the game's Nash equilibrium is the same in both environments in terms of strategies, and our experimental evidence provides some support in that regard. Subjects' bids exhibit the same patterns in both treatments and average bids are not significantly different from the expected equilibrium bid whether the externality is present or not. Bimodal bidding patterns are also observed in both our treatments, however, and while commonly observed in other all-pay auction experiments (without externalities), these patterns are not consistent with the risk-neutral model's Nash predictions. Bimodal bidding *is* consistent with Nash equilibrium in a model incorporating preferences based on prospect theory, but we show that such an equilibrium is unable to reconcile the fact that the observed bid distributions in our treatments with and without damages are not significantly different from one another. The presence of an externality therefore does not seem to alter competitive behavior in the laboratory, but this in turn questions the leading behavioral explanation for bimodal bidding. As an alternative explanation we estimate a quantal response equilibrium with preferences based on prospect theory, which better fits our data.