Essays on Auction Mechanisms and Resource Allocation in Keyword Advertising

Advances in information technology have created radically new business models, most notably the integration of advertising with keyword-based targeting, or "keyword advertising." Keyword advertising has two main variations: advertising based on keywords employed by users in search engines, often known as "sponsored links," and advertising based on keywords embedded in the content users view, often known as "contextual advertising." Keyword advertising providers such as Google and Yahoo! use auctions to allocate advertising slots. This dissertation examines the design of keyword auctions. It consists of three essays. The first essay "Ex-Ante Information and the Design of Keyword Auctions" focuses on how to incorporate available information into auction design. In our keyword auction model, advertisers bid their willingness-to-pay per click on their advertisements, and the advertising provider can weigh advertisers' bids differently and require different minimum bids based on advertisers' click-generating potential. We study the impact and design of such weighting schemes and minimum-bids policies. We find that weighting scheme determines how advertisers with different click-generating potential match in equilibrium. Minimum bids exclude low-valuation advertisers and at the same time may distort the equilibrium matching. The efficient design of keyword auctions requires weighting advertisers' bids by their expected click-through-rates, and requires the same minimum weighted bids. The revenue-maximizing weighting scheme may or may not favor advertisers with low click-generating potential. The revenue-maximizing minimum-bid policy differs from those prescribed in the standard auction design literature. Keyword auctions that employ the revenue-maximizing weighting scheme and differentiated minimum bid policy can generate higher revenue than standard fixed-payment auctions. The dynamics of bidders' performance is examined in the second essay, "Keyword Auctions, Unit-price Contracts, and the Role of Commitment." We extend earlier static models by allowing bidders with lower performance levels to improve their performance at a certain cost. We examine the impact of the weighting scheme on overall bidder performance, the auction efficiency, and the auctioneer's revenue, and derive the revenue-maximizing and efficient policy accordingly. Moreover, the possible upgrade in bidders' performance levels gives the auctioneer an incentive to modify the auction rules over time, as is confirmed by the practice of Yahoo! and Google. We thus compare the auctioneer's revenue-maximizing policies when she is fully committed to the auction rule and when not, and show that she should give less preferential treatment to low-performance advertisers when she is fully committed. In the third essay, "How to Slice the Pie? Optimal Share Structure Design in Keyword Auctions," we study the design of share structures in keyword auctions. Auctions for keyword advertising resources can be viewed as share auctions in which the highest bidder gets the largest share, the second highest bidder gets the second largest share, and so on. A share structure problem arises in such a setting regarding how much resources to set aside for the highest bidder, for the second highest bidder, etc. We address this problem under a general specification and derive implications on how the optimal share structure should change with bidders' price elasticity of demand for exposure, their valuation distribution, total resources, and minimum bids.