Private Enterprise and Financial Markets > Infrastructure and Financial Markets > Infrastructure
Revenue-Based Auctions and Unbundling Infrastructure Franchises
By Eduardo Engel, Ronald Fisher, Alexander Galetovic (12/97, IFM-112, En)
Abstract
Given the difficulties facing regulators in developing countries, a particularly promising approach for private is to auction infrastructure franchises. There are many well-known advantages to be gained from franchising infrastructure projects; unfortunately, there also are a number of important pitfalls that need to be avoided to obtain these advantages. In this paper, the authors argue that most of the pitfalls arise from the fixed duration of the normal franchise contract and propose a new auction mechanism in which the term of the franchise adjusts endogenously to demand. This mechanism, which we call Least Present Value of Revenue (LPVR) auction solves many of the problems that have hindered the use of fixed lower term franchises when privatizing infrastructure projects. First, the franchise holder bears a demand risk and, as a result, users pay lower fees. Second, LPVR auctions reduce the scope for opportunistic behavior, both by the franchise holder (lowballing) and by the government (creeping expropriation). Third, socially desirable changes to the original contract (such as user fees or capacity expansions) can be implemented at low cost.
Despite these advantages, LPVR auctions are handicapped by reduced incentives for activities that raise demand. In many cases this limitation is important, as for example when service quality standards cannot be verified. However, the scope of LPVR auctions can be increased significantly by unbundling projects in two parts, one that captures the advantage of LPVR auctions, and another that mitigates the lack of incentives to stimulate demand.
This paper was prepared for the Conference on Alternatives to Traditional BOTs for Financing Infrastructure Projects, sponsored by the Inter Amrican Development Bank, held in Washington, D.C. on June 3, 1997. The views and opinions expressed in this paper are those of the authors and do not necessarily reflect the official position of the Inter-American Development Bank, or any institution affiliated with the authors. This paper may not be quoted or referred to by citation without written permission of the Inter-American Development Bank.
Last updated: 01/29/07
