Disincentivising overbidding for toll road concessions

2 │ LITERATURE REVIEW
Criticism
As noted in the literature, the winner’s curse suggests that bidders systematically act in an irrational manner:
Economists typically treat such claims [of a winner’s curse] with caution as they imply that bidders repeatedly err,
in violation of basic notions of economic rationality. 26
The winner’s curse cannot occur if all bidders are rational...so evidence of a winner’s curse in market settings
would represent an anomaly. 27
Accordingly, it has been argued that rational bidders would lower their bids in order to allow for the bidding of
competitors. 28
This leads to the question of why overbidding still occurs if it is not a rational strategy in the bidding process. Would
construction companies not go bankrupt if they continually overbid for projects One explanation might be that the
common-value assumption is overly restrictive in the context of toll road concessions. This might be the case for two
reasons.
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Strategic behaviour—bidders may face considerable political or economic pressures to overbid, in order to win
the right to carry out the project. For example, the company may wish to curry political favour, with a view to
gaining economic rents in the future on the back of an ‘investment’ in the current project. Alternatively, bidding
teams may stand to gain financially from winning the project rights, in the form of performance-linked bonuses.
The potential for such strategic misrepresentation is discussed in more detail below.
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‘Entrepreneurship’—as argued by Brätland (2011), the value of the concession to each bidder is likely to be
determined by endogenous factors and not an exogenous, common value. 29 That is, a firm may be able to benefit
from applying innovative processes or from synergies with existing projects which would increase the value they
would obtain from ownership of the capital good, relative to the value that would be accrued by other bidders.
This is likely to be particularly the case when the concessions confer a greater amount of responsibility on a
single contractor. In design, build, finance, operate, and maintain (DBFOM) concessions, for example, the bidders
may be differentiated by their access to financing, the input prices they face, their design capabilities, and so on.
The literature has also highlighted the potential for complementarities between toll roads and other business
areas which might give some firms an advantage over others.
A second literature has taken account of the potential for strategic behaviour in concessions bidding, and has also
suggested that overbidding could result from cognitive biases in planners’ decision-making. The tendency for bidders
to make inaccurate estimates due to optimism bias and strategic misrepresentation (lying) are examined below.
2.2.2 Optimism and other cognitive biases
Much of the behavioural economics literature has been built on Simon’s (1957) notion of bounded rationality. 30
According to this view, decision-makers are constrained by cognitive, temporal and informational limitations, and
arrive at solutions by picking from a restricted set of choices. As an example of this in practice, it has been suggested
that, in assessing the probability of future outcomes, decision-makers tend to be optimistically biased, in that they
exhibit a tendency to overestimate the likelihood of favourable future outcomes and underestimate the likelihood
of unfavourable future outcomes. 31 This would suggest that, in considering future traffic volumes for toll roads,
politicians and bid teams may short-sightedly overestimate the popularity of the road while giving insufficient weight
to the probability of a negative volume shock or slower-than-expected GDP or population growth.
26 Kagel and Levin (1986), op. cit., p. 894.
27 Thaler, R.H. (1988), ‘Anomalies: The Winner’s Curse’, Journal of Economic Perspectives, 2:1, p. 192.
28 Cox, J.C. and Isaac, R.M (1984), ‘In Search of the Winner’s Curse’, Economic Inquiry, 22:4, 579–92.
29 Brätland, J. (2011), ‘The Myth of the Winner’s Curse in Auctions of Capital Goods’, The Quarterly Journal of Austrian Economics, 14:1, 25–52.
30 Simon, H. (1957), ‘A Behavioural Model of Rational Choice’, in Models of Man, Social and Rational: Mathematical Essays on Rational Human
Behaviour in a Social Setting, New York: Wiley.
31 See, for example, Irwin, F.W. (1953), ‘Stated expectations as a function of probability and desirability of outcomes’, Journal of Personality, 21,
329–35; Weinstein, N. (1980), ‘Unrealistic optimism about future life events’, Journal of Personality and Social Psychology, 39, 806–20.
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