The Paradox of Concessions in Developing Countries: A game-theoretic investigation of airport concessions in Brazil

After a first wave of privatizations in Latin America in the 1980s, the return of conservative governments in the region points to a renewed cycle of concessions. This paper presents a game-theoretic analysis of airport concessions that explicitly takes into account the two distinct, interacting phases of the concession mechanism: the concession auction and the operation game. The concession contract sets an investment to be made during operation, but the concessionaire may benefit from underinvesting and renegotiating the concession contract with the regulator . The paper shows that the weaker a country's institutions are, the higher is the probability of underinvestment, and the higher are the auction equilibrium concession fees. This is the "Paradox of Concession" : the more successful the auction is, the less likely the operation will be effective. This research proposes a new mechanism based on benefits for investment rather than punishment for underinvestment with the following properties : It is efficient; frees the government from the weak -institutions problem; increases auction bids; eliminates the "paradox of concessions"; and can be fine-tuned to reduce the likelihood of underinvestment.