Least-Present-Value-of-Revenue Auctions and Highway Franchising
AbstractIn recent years several countries have started massive highway franchising programs auctioned to private firms. In these auctions, the regulator typically sets the franchise term and firms bid on tolls, or, alternatively, the regulator sets tolls and the winner is the firm that asks for the shortest franchise term. In this paper we argue that many of the problems that highway franchises have encountered are due to the fact that the franchise term cannot adjust to demand realizations. We propose a new auction mechanism where the firm that bids the least present value of revenue from tolls (LPVR) wins the franchise. With this scheme, the franchise length adjusts endogenously to demand realizations. Assuming that the regulator is not allowed to make transfers to the franchise holder that firms are unable to diversify risk completely due to agency problems auctions are optimal, even when the regulator does not know firms' construction costs. Furthermore, for demand uncertainty and risk aversion parameters typical of developing countries, welfare gains associated with substituting a LPVR auction for a fixed-term auction are large (e.g. one-third of the cost of the highway).
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Bibliographic InfoPaper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 6689.
Date of creation: Aug 1998
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Publication status: published as Engel, Eduardo M. R. A., Ronald D. Fischer and Alexander Galetovic. "Least-Present-Value-Of-Revenue Auctions And Highway Franchising," Journal of Political Economy, 2001, v109(5,Oct), 993-1020.
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Other versions of this item:
- 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, University of Chicago Press, vol. 109(5), pages 993-1020, October.
- Eduardo Engel & Ronald Fischer & Alexander Galetovic, 1998. "Least-Present-Value-of-Revenue Auctions and Highway Franchising," Documentos de Trabajo, Centro de EconomÃa Aplicada, Universidad de Chile 37, Centro de Economía Aplicada, Universidad de Chile.
- D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
- H42 - Public Economics - - Publicly Provided Goods - - - Publicly Provided Private Goods
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- Arrow, Kenneth J & Lind, Robert C, 1970. "Uncertainty and the Evaluation of Public Investment Decisions," American Economic Review, American Economic Association, American Economic Association, vol. 60(3), pages 364-78, June.
- Riordan, Michael H & Sappington, David E M, 1987. "Awarding Monopoly Franchises," American Economic Review, American Economic Association, American Economic Association, vol. 77(3), pages 375-87, June.
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