Disincentivising overbidding for toll road concessions

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DISINCENTIVISING OVERBIDDING FOR TOLL ROAD CONCESSIONS 2.2.9 Discussion After more than thirty years of study, the winner’s curse literature is well developed and provides some important insight into the extent of overbidding in common value auctions.. However, while the winner’s curse provides a useful foundation for considering overbidding, the common value assumption is restrictive in the case of toll road concessions, since it ignores the potential for strategic bidding and entrepreneurship in the utilisation of the assets. 49 Optimism bias alone is unlikely to explain the observed forecasting bias in its entirety, but it is an observed phenomenon which likely plays some part in overbidding, 50 particularly in the infancy of toll road concessioning. As such, the impact of optimism bias needs to be considered in combination with analysis of the incentives within the procurement process that lead to strategic bidding. 51 It is these strategic incentives which are likely to provide the greatest explanatory power in determining the cause of overbidding. In the context of cost underestimation in construction concessions, Flyvbjerg et al. (2002) argue that overbidding stems from lying and deceit: The use of deception and lying as tactics in power struggles aimed at getting projects started and at making a profit appear to best explain why costs are highly and systemically underestimated in transportation infrastructure projects. 52 However, this suggests that bidders are knowingly acting outside the law, which appears to be highly unlikely. It is more likely that public and private sector agents identify what is needed to win—either in terms of getting their scheme off the ground, or in ensuring that their team wins the bid—and ‘play the game’ accordingly, within the confines of legal practice. While the concept of strategic misrepresentation is very useful in considering the overbidding problem, it should not be thought of in terms of intentional deceit per se. Rather, strategic misrepresentation should be thought of in the context of how public and private sector agents react to the incentives within the concessions process, where these incentives are determined by the criteria against which competing schemes are assessed, the requirements of the ITT, the method of bid appraisal, and so on. The onus in tackling the problem of overbidding should be on ensuring that the incentives within the concessions process are aligned with the provision of well-justified, (possibly) conservative demand and revenue forecasts; rather than on penalising the agents who respond to the current incentives to do otherwise. Solutions to the overbidding problem therefore need to take account of—and, where possible, attempt to address—these strategic factors. 49 Brätland (2011), op. cit. 50 Flyvbjerg (2011), op. cit. 51 Ibid. 52 Flyvbjerg et al (2002), op. cit., p. 290. 20
2 │ LITERATURE REVIEW 2.3 Potential solutions This section identifies potential solutions that have been put forward in the literature. These are not necessarily recommendations. The report’s recommendations are presented in section 5 and incorporate additional insight from the case studies (sections 3 and 4) and interviews undertaken by the authors, alongside findings from the literature. The solutions look to address problems broken down into five stages of the concessions process, as shown in Figure 2.1 below. Each of these stages is considered in turn, below. Figure 2.1 Stages in the concessions process Pre-procurement Concession design Bidding process Bid Appraisal Post-contract award How is this project justified What are parties bidding for How is bidding organised What criteria are bids judged against What happens after the contract is awards •• public sector optimism and strategic forecasting •• political pressures Source: Oxera. •• risk transfer •• private sector optimism bias •• strategic bidding •• structure of bid teams •• winner’s curse •• objective: revenue maximisation or efficient use of resource •• incentive compatibility •• technical errors •• renegotiation 2.3.1 Pre-procurement phase In the UK, certain steps are put into place to ensure that projects are given the go-ahead only where they can be clearly justified. This should provide a level of protection against political opportunism in scheme generation, although it is unlikely that any framework will be able to eradicate such opportunism completely. In particular, public spending decisions are made by taking account of whether schemes: •• are supported by ‘a robust case for change that fits with wider public policy objectives’—this is termed the ‘strategic case’; •• demonstrate value for money—the ‘economic case’; •• are commercially viable—the ‘commercial case’; •• are financially affordable—the ‘financial case’; and •• are achievable—the ‘management case’. 53 Therefore, a key aspect in determining whether a scheme should go ahead, and how the procurement and delivery processes should be designed, involves analysis in the context of a value-for-money (VfM) framework. This represents the ‘economic case’ for the project. Indeed, the Accounting Officer of each government department—who is required to sign off all departmental projects—has a duty to ensure VfM in public spending. HM Treasury has therefore set out guidelines for how VfM can be assessed. 54 53 Department for Transport (2011), ‘Transport Business Case’, April, p. 3. 54 HM Treasury (2006), ‘Value for Money Assessment Guidance’, November, p. 8. 21
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Disincentivising overbidding for toll road concessions

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