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How to Auction an Essential Facility When Underhand Integration Is Possible

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Author Info

  • Eduardo Engel

    (Cowles Foundation)

  • Ronald Fischer

    (University of Chile)

  • Alexander Galetovic

    (University of Chile)

Abstract

Regulating seaports is difficult in general, even more so for the weak regulatory institutions common in developing countries. For this reason some countries have awarded these facilities via Demsetz auctions, to the port operator that bids the lowest cargo-handling fee. A major concern with Demsetz auctions in this context, is that the winning operator may integrate with a shipper and monopolize the shipping market, by worsening the service quality for competing shippers. The standard policy recommendation against service quality discrimination is to ban the seaport from operating in the shipping market. The effectiveness of such prohibitions is suspect, however, because they can be circumvented by an (illegal) underhand agreement between the port operator and the shipper. In this paper we show that a ban on integration increases welfare if it is combined with a (sufficiently high) floor on the cargo-handling fee that operators can bid in the auction. In the absence of such a floor, however, a Demsetz auction is worse than no regulation at all of the bottleneck monopoly. Our results apply beyond the port and shipping markets, to any essential facility that can monopolize a downstream market. The results only require that profits with underhand vertical integration agreements be less than with legal vertical integration.

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Bibliographic Info

Paper provided by Cowles Foundation for Research in Economics, Yale University in its series Cowles Foundation Discussion Papers with number 1353.

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Length: 21 pages
Date of creation: Feb 2002
Date of revision:
Publication status: Published in Journal of Industrial Economics (September 2004), 52(3): 427-455
Handle: RePEc:cwl:cwldpp:1353

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Postal: Yale University, Box 208281, New Haven, CT 06520-8281 USA
Phone: (203) 432-3702
Fax: (203) 432-6167
Web page: http://cowles.econ.yale.edu/
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Postal: Cowles Foundation, Yale University, Box 208281, New Haven, CT 06520-8281 USA

Related research

Keywords: Auctions; ex ante vs. ex post rents; Demsetz auctions; hidden action; monopoly regulation; productive efficiency; vertical integration;

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References

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  1. Harstad, Ronald M & Crew, Michael A, 1999. "Franchise Bidding without Holdups: Utility Regulation with Efficient Pricing and Choice of Provider," Journal of Regulatory Economics, Springer, vol. 15(2), pages 141-63, March.
  2. Juan Foxley & José Luis Mardones, 2000. "Port Concessions in Chile : Contract Design to Promote Competition and Investment," World Bank Other Operational Studies 11418, The World Bank.
  3. Oliver E. Williamson, 1976. "Franchise Bidding for Natural Monopolies -- in General and with Respect to CATV," Bell Journal of Economics, The RAND Corporation, vol. 7(1), pages 73-104, Spring.
  4. Daniel F. Spulber, 1989. "Regulation and Markets," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262192756, December.
  5. Eduardo M.R.A. Engel & Ronald D. Fischer & Alexander Galetovic, 1998. "Least-Present-Value-of-Revenue Auctions and Highway Franchising," NBER Working Papers 6689, National Bureau of Economic Research, Inc.
  6. Lee, Sang Hyup & Hamilton, Jonathan H, 1999. "Using Market Structure to Regulate a Vertically Integrated Monopolist," Journal of Regulatory Economics, Springer, vol. 15(3), pages 223-48, May.
  7. Economides, Nicholas, 1999. "Quality choice and vertical integration," International Journal of Industrial Organization, Elsevier, vol. 17(6), pages 903-914, August.
  8. Lourdes Trujillo & Gustavo Nombela, 2000. "Multiservice Infrastructure : Privatizing Port Services," World Bank Other Operational Studies 11417, The World Bank.
  9. Jean-Jacques Laffont & Jean Tirole, 2001. "Competition in Telecommunications," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262621509, December.
  10. Besanko, David, 1985. "Multi-period contracts between principal and agent with adverse selection," Economics Letters, Elsevier, vol. 17(1-2), pages 33-37.
  11. Riordan, Michael H & Sappington, David E M, 1987. "Awarding Monopoly Franchises," American Economic Review, American Economic Association, vol. 77(3), pages 375-87, June.
  12. Vickers, John, 1995. "Concepts of Competition," Oxford Economic Papers, Oxford University Press, vol. 47(1), pages 1-23, January.
  13. Economides, Nicholas, 1998. "The incentive for non-price discrimination by an input monopolist," International Journal of Industrial Organization, Elsevier, vol. 16(3), pages 271-284, May.
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Citations

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Cited by:
  1. Engel, Eduardo & Fischer, Ronald & Galetovic, Alexander, 2005. "Highway franchising and real estate values," Journal of Urban Economics, Elsevier, vol. 57(3), pages 432-448, May.
  2. Eduardo Engel & Ronald Fischer & Alexander Galetovic, 2002. "Competition In Or For The Field: Which Is Better?," Documentos de Trabajo 115, Centro de Economía Aplicada, Universidad de Chile.
  3. Ronald Fischer & Rodrigo Gutiérrez & Pablo Serra, 2002. "The Effects of Privatization on Firms and on Social Welfare," Documentos de Trabajo 131, Centro de Economía Aplicada, Universidad de Chile.
  4. Alexander Galetovic, 2003. "Integración Vertical en el Sector Eléctrico: Una guía para el usuario (Vertical integration in the electricity sector)," Documentos de Trabajo 158, Centro de Economía Aplicada, Universidad de Chile.
  5. Eduardo Engel & Ronald Fischer & Alexander Galetovic, 2002. "Highway Franchising and Real Estate Values," Working Papers 840, Economic Growth Center, Yale University.
  6. Rodrigo Gutierrez & Pablo Serra & Ronald Fischer, 2003. "The Effects of Privatization on Firms and on Social Welfare: The Chilean Case," Research Department Publications 3150, Inter-American Development Bank, Research Department.
  7. Eduardo Engel & Ronald Fischer & Alexander Galetovic, 2002. "Competition In or For the Field: Which is Better," Working Papers 844, Economic Growth Center, Yale University.

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