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How to Auction an Essential Facility When Underhand Integration is Possible

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  • Eduardo Engel

    ()
    (Department of Economics, Yale University)

  • Ronald Fischer
  • Alexander Galetovic
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    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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    File URL: http://www.econ.yale.edu/growth_pdf/cdp839.pdf
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    Bibliographic Info

    Paper provided by Economic Growth Center, Yale University in its series Working Papers with number 839.

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    Length: 20 pages
    Date of creation: Feb 2002
    Date of revision:
    Handle: RePEc:egc:wpaper:839

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    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. Daniel F. Spulber, 1989. "Regulation and Markets," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262192756.
    2. 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.
    3. Besanko, David, 1985. "Multi-period contracts between principal and agent with adverse selection," Economics Letters, Elsevier, vol. 17(1-2), pages 33-37.
    4. Eduardo M. R. A. Engel & Ronald D. Fischer & Alexander Galetovic, 2001. "Least-Present-Value-of-Revenue Auctions and Highway Franchising," Journal of Political Economy, University of Chicago Press, vol. 109(5), pages 993-1020, October.
    5. 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.
    6. Vickers, John, 1995. "Concepts of Competition," Oxford Economic Papers, Oxford University Press, vol. 47(1), pages 1-23, January.
    7. Economides, Nicholas, 1999. "Quality choice and vertical integration," International Journal of Industrial Organization, Elsevier, vol. 17(6), pages 903-914, August.
    8. Riordan, Michael H & Sappington, David E M, 1987. "Awarding Monopoly Franchises," American Economic Review, American Economic Association, vol. 77(3), pages 375-87, June.
    9. Jean-Jacques Laffont & Jean Tirole, 2001. "Competition in Telecommunications," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262621509.
    10. 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.
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