Least-Present-Value-Of-Revenue Auctions and Highway Franchising

45 Pages Posted: 4 Sep 1998 Last revised: 6 Sep 2001

See all articles by Eduardo M. R. A. Engel

Eduardo M. R. A. Engel

Yale University - Department of Economics; National Bureau of Economic Research (NBER)

Alexander Galetovic

Universidad Adolfo Ibáñez; Stanford University - The Hoover Institution on War, Revolution and Peace; University of Padua - CRIEP

Ronald D. Fischer

University of Chile - Center of Applied Economics (CEA)

Multiple version iconThere are 3 versions of this paper

Date Written: August 1998

Abstract

In recent years several countries have started massive highway franchising programs auctioned to private firms. In these auctions, the regulator typically sets the franchise term and firms bid on tolls, or, alternatively, the regulator sets tolls and the winner is the firm that asks for the shortest franchise term. In this paper we argue that many of the problems that highway franchises have encountered are due to the fact that the franchise term cannot adjust to demand realizations. We propose a new auction mechanism where the firm that bids the least present value of revenue from tolls (LPVR) wins the franchise. With this scheme, the franchise length adjusts endogenously to demand realizations. Assuming that the regulator is not allowed to make transfers to the franchise holder that firms are unable to diversify risk completely due to agency problems auctions are optimal, even when the regulator does not know firms' construction costs. Furthermore, for demand uncertainty and risk aversion parameters typical of developing countries, welfare gains associated with substituting a LPVR auction for a fixed-term auction are large (e.g. one-third of the cost of the highway).

Suggested Citation

Engel, Eduardo M. and Galetovic, Alexander and Fischer, Ronald D., Least-Present-Value-Of-Revenue Auctions and Highway Franchising (August 1998). NBER Working Paper No. w6689. Available at SSRN: https://ssrn.com/abstract=122348

Eduardo M. Engel (Contact Author)

Yale University - Department of Economics ( email )

28 Hillhouse Ave
New Haven, CT 06520-8268
United States
203-432-5595 (Phone)
203-432-5779 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Alexander Galetovic

Universidad Adolfo Ibáñez ( email )

Peñalolén
Santiago
Chile

Stanford University - The Hoover Institution on War, Revolution and Peace ( email )

Stanford, CA 94305-6010
United States

University of Padua - CRIEP ( email )

Padua
Italy

Ronald D. Fischer

University of Chile - Center of Applied Economics (CEA) ( email )

Republica 701
Casilla 2777
Santiago
Chile
+56/2/678 4055 (Phone)
+56/2/689 7895 (Fax)

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