Disincentivising overbidding for toll road concessions

DISINCENTIVISING OVERBIDDING FOR TOLL ROAD CONCESSIONS
2.2 Potential explanations
2.2.1 The winner’s curse
The tender design determines the process by which bids are made in concessions contracting, and the price paid by
the winner. One way to consider this is in the context of auction theory. Although procurement in the Australian toll
roads sector does not follow an archetypal auction format, contract award has been closely influenced by the size of
the upfront payment offered by the bidding consortia. As such, there is potential for auction theory to provide insight
into how tendering processes can be designed to ensure optimal bidding and into the reasons why an overbidding
problem may arise
The literature has distinguished between two (pure) types of auction, according to the value assumptions on which
they are founded:
••
private-value auctions—bidders each value the item differently and, while each is certain of their own valuation,
there is uncertainty about the value of the item to other bidders;
••
common-value auctions—the ‘true’ value of the item is the same to all bidders, but each has a different estimate
regarding the underlying value, based on the signals they receive prior to bidding. As such, a feature of commonvalue
auctions is that bidders do not know the value of the item at the time of bidding. The common-value
assumption has most frequently been applied to the analysis of auctions for mineral rights, but has also been
used in the toll road context. 20
To the extent that a toll road concession has the same value to all bidders, the procurement process can be thought
of in the context of a common-value auction. In this framework, overbidding might be explained by the ‘winner’s
curse’. This problem is well-developed (and has been extensively discussed) in the economics literature, and thus
provides a reasonable starting point for considering the overbidding problem.
The theory
The winner’s curse refers to the phenomenon by which winning bidders are found to have systematically bid amounts
that are greater than the ‘true’ value of the auctioned item, and thus either lose money or obtain less profit than the
winning bidder anticipated. Potential winner’s curse problems have been highlighted in auctions for oil field leases in
the Outer Continental Shelf, 21 book publication rights, 22 the free agency market for professional baseball players, 23
and corporate takeover markets, 24 among others.
The occurrence of the winner’s curse follows from the common-value assumption. All bidders would attach the same
value to the item (e.g., the concession) if they had perfect information, but since no party knows the actual value of
the item ex ante, each makes an estimate of its value based on the information available to them prior to bidding. In
the case of toll road concessions, the available information might, for example, take the form of demand and revenue
forecasts.
If the bidders’ estimates are unbiased, the average of the estimates would be expected to equal the true value.
However, the estimates that the bidders arrive at on the basis of their forecasts could potentially vary significantly—
some will overstate the value of the item; others will understate it. Since the winning bidder will be the party with the
highest estimate of those competing for the item, it will typically have overestimated the item’s value.
This problem arises because bidders do not take account of the fact that their bid should be based on the value of
the item conditional on the event of winning. 25 That is, their bids should take account of the fact that, if they win the
auction, they will have paid more than anyone else was willing to.
20 See, for example, Athias, L. and Nunez, A. (2008), ‘The More the Merrier Number of Bidders, Information Dispersion, Renegotiation and
Winner’s Curse in Toll Road Concessions’, MPRA Paper 10539, University Library of Munich, 1–30.
21 Capen, E.C., Clapp, R.V. and Campbell, W.M. (1971), ‘Competitive Bidding in High-Risk Situations’, Journal of Petroleum Technology, 23, 618–34.
22 Dessauer, J.P. (1981), Book Publishing, New York: Bowker.
23 Cassing, J. and Douglas, R.W. (1980), ‘Implications of the Auction Mechanism in Baseball’s Free Agent Draft’, Southern Economic Journal, 47,
110–21.
24 Miller, E.M. (1977), ‘Risk, Uncertainty, and Divergence of Opinion’, Journal of Finance, 32, 1151–68; Roll, R. (1986), ‘The Hubris Hypothesis of
Corporate Takeovers’, Journal of Business, 59, 197–216.
25 Kagel, H. and Levin, D. (1986),‘The Winner’s Curse and Public Information in Common Value Auctions’, American Economic Review, 76:5,
894–920.
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