The 'asymmetric contracting' risk with auctions

The Economic Times reports that the just concluded FM radio auctions resulted in aggressive bidding in the metros and no bidders in 13 towns,

With bids in metro cities that far exceed what operators had expected, the auction has the broadcast industry wondering if it is subscribed to the winner's curse. The bid price for a station in Mumbai was Rs 122.8 crore, Delhi Rs 169.2 crore and Bangalore Rs 109.3 crore, while 38 stations in 13 cities had received no bids at all because of high reserve prices. Just these three metro circles account for 45% of the total bids received... For the major cities there is now a significant scarcity premium... this is a direct result of reducing the number of stations being auctioned in the "premium" locations — top cities into which all operators will rush, in order to preserve their businesses.

After the tumult surrounding sordid crony capitalism in the discretionary allocation of natural resources, India has embraced auctions with vengeance. Coal, telecom spectrum, mineral resources, and now petroleum reserves are being auctioned and notional receipts are being booked. Nobody doubts the intent behind these auctions and everybody applauds the efficiency with which they are being carried out. But the long-term sustainability of these auctions may not be as robust as it appears (more on this is in a later post). Is it therefore a case of the cliched 'operation successful, but patient dead'?

Most infrastructure projects in developing countries are characterized by several uncertainties. The commonest problem relates to site allocation and environmental and other clearances, which are par for the course for any project, and whose delays immediately translate into cost escalation. Then, there are the market risks, arising from lower than expected traffic forecasts or smaller market. Finally, there are the inevitable costs associated with rent-seeking, which no entrepreneur can escape. 

Under ideal conditions, market participants factor in all these elements when they make their bids, resulting in market-competitive price discovery. But in the real world, market participants suffer from cognitive biases (over-estimations of their ability to control the pace and trajectory of the development, in accordance with their laid out plans), and ex-ante overlook these factors when making their bids. Developers instinctively refuse to acknowledge errors in their business cases. Since these real factors generally always strike, the successful bidders are ex-post left with no option but to resile from their commitments. They skimp on their investments or renegotiate. The tortured fate of infrastructure projects, in the form of stalled projects, is for all to see. 

All this, coupled with winner's curse and moral hazard (from the inevitability of renegotiations), generates an asymmetric contracting, where efficiency in the price discovery process intersects with inefficiencies in the project development eco-system, amplified by human cognitive biases, resulting in a low-level equilibrium. But the politics associated with the auctions system, especially given the context in which it was embraced, may prove insurmountable to permit any tinkering with it, leave aside replacement.