WPS-1 957
BIDDING FOR CONCESSIONS
MICHAEL KLEIN
FILE COPY



Bidding for Concessions                                                         Page 2
ABSTRACT
Privatization of infrastructure ventures in sectors such as energy, telecommnunications,
transport and water has become popular over the last decade. Often - for good or bad reasons -
private firms are given monopoly franchises under some type of long-term concession agreement,
for example "Build-Operate-Transfer" schemes. The article surveys the issues arising in designing
concession contracts and in awarding them to private parties. It is crucial to define performance
specifications as well as incentive and risk-sharing parameters comprehensively and consistently
both to achieve efficient performance by the concessionaire and to miniimize post-award re-
negotiation.  Concession award should as a rule be made competitively, unless special
requirements of speed, innovation or excessive transaction costs argue otherwise. Typically,
competitive concession award is made by first price sealed bids. There are strong arguments,
however, to consider open auctions more seriously in a number of cases. Auctions may also be
re-awarded by way of auction. However, somewhat arbitrary bid preferences may have to be set.
Auctioneers for complex concession contracts should operate at arms-length form all interested
parties, including politicians. It may be sensible to let independent agencies that regulate the
concession scheme run the auction.



Bidding for Concessions                                                     Page 3
BIDDING FOR CONCESSIONS
TABLE OF CONTENTS
I. INTRODUCTION .1
II. WHAT TO AWARD - CONTRACT DESIGN.                                            3
III. To AUCTION OR NOT TO AUCTION? .8
IV. HoW TO AUCTION .15
V. WHO AUCTIONS .20
VI. CONCLUSIONS .21
BIBLIOGRAPHY ..................................................................  23



I. INTRODUCTION
In recent years governments in over a hundred countries have tried to attract private firms
and capital to manage infrastructure businesses such as telecommunications, water, natural gas
and electricity systems as well as transport infrastructure (roads, ports, airports and railroads).
Sometimes existing businesses have been privatized in countries such as Argentina, Bolivia,
Chile, New Zealand and the United Kingdom. Other governments have tried to construct new
facilities under private auspices without necessarily privatizing existing assets as in China,
Colombia, Indonesia and India.' In the United States, regulated utilities have sub-contracted
many power stations.
The exact nature of private participation in these businesses varies. Differing forms of
private participation reflect varying risk-sharing arrangements between investors, consumers and
taxpayers ("the government"). Essentially one may distinguish four main risks (operations, fee
collection, financing and construction) which may be shifted to the private sector in all imaginable
combinations and sub-divisions. In some cases, private parties are allowed to operate a business
but not to own it. Such is the case of the water system in Guinea (Conakry). Arrangements
where private parties take only operating and collection risk have historically been widespread in
the French water sector (affermage). In other cases, private parties also take on investment and
financing risk as in the popular build-operate-transfer (BOT) model, under which a private
company finances, constructs and operates a venture before turning it back to the government. A
number of water treatment plants (e.g. Puerto Vallarta in Mexico) or independent power plants
(most of them in the United States and the Philippines) have followed this approach. There are
also build-lease-transfer (BLT) approaches, where the private sector constructs and finances, but
the public sector operates (several Mexican power plants).
Regardless of the differences in approach, a common concern surrounds most infrastructure
privatizations. Many of the newly private businesses have monopoly power either because even
with free entry into the industry only one firm would survive (natural monopoly) and/or because
governments have given exclusive rights to the private companies (legal monopoly).   When
privatization simply transforms a public monopoly into a private one, public concern over possible
exploitation can be quite high. To get a good deal for taxpayers and consumers and to prevent
private exploitation of monopoly power, it is often advocated that rights to infrastructure
businesses be competitively auctioned to private parties. Sometimes auctions are on the basis of
the lowest price for consumers (e.g. Buenos Aires and Manila water concessions and many
independent power plants) or on the basis of the highest revenue for the fiscal authorities (e.g.
many telecommunications ventures). Fundamentally, it should be noted that the very issue of
designing and awarding concessions only arises if market entry is not free. For example, it makes
no sense to define and award power generation concessions in a competitive power electricity
system, for example, in Argentina.2
' It should also be noted that private regulated utilities in some countries have contracted out parts of their
business to other private companies, most notably electric utilities in the USA which allowed independent power
producers (IPPs) to supply new generating capacity.
2 Even in free entry systems permission to use rights of way or environmental clearances are awarded by
government authorities. Such permissions, authorisations or licenses could theoretically be awarded in ways



Biddingfor Concessions                                                          Page 2
It is often argued that private rights be limited in time so that the government can either take
over the business or re-auction it to the private sector. This is meant to enable the government to
limit exploitation by private monopolists in the future as well. In this paper the transfer of
property rights, which governments can limit in time, are called concessions.3 These time limits
may either be fixed in advance (e.g. French water concessions) or they may be a function of the
economic performance of the concession (e.g. Dartford toll tunnel in the United Kingdom) or they
may be imposed by government discretion through termination without fault (e.g. French and
British private water businesses) or any mix of such rules.
More broadly governments may wish to limit property rights so as to prevent pockets of
private monopoly power from holding up system development. For example, governments may
have rights of eminent domnain to expropriate property owners who for some reason refuse to sell
their property to make way for a road or some other right-of-way or let it be used that way.
Views about the best way to award concessions continue to be debated. Some would like
to apply standard rules modelled on those for the procurement of equipment and civil works. In
most countries these rules tend to require some form of competitive award procedure except for
special cases. Others argue that concession contracts differ fundamentally from contracts for
equipment and civil works, because they establish a long lasting relationship and are more than a
one-off purchase. Analogies to marriage relations are sometimes used: "It is not the number of
suitors and the size of the dowry that truly matters for a successful marriage". That analogy has
been used by proponents of the traditional French system of concession award, which gave
mayors full discretion in how to define and award, for example, municipal water concessions and
exempted such awards from the normal rules governing other types of procurement Yet another
marriage rhyme from Germany might be used to illustrate the opposite position: "Drum pruefe
wer sich ewig bindet, ob er nicht noch was bess'res findet" ("Whoever is about to make eternal
vows, should test whether he cannot find a better partner").
Whatever one may think about the adequacy of such analogies, they go to the heart of the
matter. The question is whether an auction can help obtain the best terms for a concession
arrangement from the point of view of the conceding authority. If there are reasons to believe
that substantial re-negotiations may become necessary during the life of a concession the original
bidding may be rendered close to meaningless. In that case it becomes most important to chose a
trustworthy, reputable concessionaire and to negotiate well. In a way, the process of choosing a
concessionaire would then look more like that of choosing an important employee. Competence,
character and chemistry would be crucial. "Interviews" would be the method of choice for
awarding the contract rather than an auction.
This paper reviews the key issues and provides a view on the relevance of auction theory for
practical policy governing concession award. The debate is typically over
* what is to be awarded, i.e. the contract design;
* whether competitive bidding or negotiation should be used to make the award;
similar to concession contracts, for example prior to the entry new power plants. An example would be auctions of
pollution rights.
3 In the economics literature the word "franchise" tends to be used for the concept.



Bidding for Concessions                                                         Page 3
* how competitive bidding be structured; and
. who conducts the auctions and who monitors the performance of concessionaires
subsequently.
II. WHAT TO AWARD - CONTRACT DESIGN
Contract design is here interpreted in a broad sense.  It covers all the specifications and
incentives that govern a concession whether included in a specific concession contract or
elsewhere in laws, regulations or the like.  In some cases, particularly where concessions and
related law as well as regulations are new, concession contracts may be rather thick documents
running into hundreds of pages and several volumes, for example for the Buenos Aires water
concession. In France, on the other hand, a long tradition with concessions has led to short
documents which set concession-specific parameters. Many other rules governing the concession
are contained in more general laws or the precedents developed by over a hundred years of
relevant jurisprudence.
In essence, concession contracts set out (1) the performance obligations and rights of
concessionaires and the (2) incentives and risks under which they would operate including pricing
arrangements. The clarity with which these can be defined determines whether (3) there is likely
to be re-negotiation after contract award, which may undermine the significance of the initial
auction. The design of incentives and risk allocation will affect the intensity of competition
initially and subsequently the sustainability of the original contract. Consider first the issue of
specifying performance obligations.
Performance specifications
A key goal in drafting contracts is to ensure as best as possible that contracts are clear and
comprehensive so as to reduce the likelihood of re-negotiation. At the same time contracts need
to provide freedom to the concessionaire to come up with efficient and innovative solutions.
Output targets. Some argue that, ideally, a conceding authority would define clear and
unambiguous performance targets for service delivery by the concessionaire, but not to make
rules on how to achieve them. This sounds right in principle wherever some form of price
regulation governs the concession. Wherever prices are regulated there needs to be some
regulation of service quality to prevent the concessionaire from reaping excess profits by skimping
on quality. However, it is difficult to be clear and comprehensive in defining service targets.
Governments tend to be nervous about providing only very general performance obligations
fearing that the concessionaire will do less than government deems necessary. An example
occurred in the United Kingdom when a BOT contract for a prison was granted to a private
company under the country's private finance initiative. It turned out that the winning company
was successful, because it planned on housing several prisoners in a cell, whereas the government
wanted single occupancy, but had forgotten to specify this in the tender documents.
Investment obligations. More often governments like to specify obligations of the
concessionaire not only in terms of type of service to be delivered, but also in terms of
investments to be carried out in support of these objectives. They may require certain investments
to be carried out or prescribe technical solutions etc. This carries obvious risks. When Argentine



Biddingfor Concessions                                                                    Page 4
freight railways were privatized they were given certain investment targets. However, their
market did not develop as planned rendering the investments foreseen in the contract
superfluous.4
Some form of contract re-negotiation has often been necessary in cases such as the ones
described above. Such re-negotiation could have been avoided with greater care in contract
design. Often extensive consultations about specification design and clarification meetings with
bidders are helpful to arrive at sound contracts.
Unverifiable quality. However, there are also reasons, why contract specifications may
need to specify input requirements and not just performance. For example, where service quality
cannot be adequately measured certain technical solutions may be prescribed to ensure some
minimum standards. This has happened in the case of coal-fired power plants where, for example,
the installation of scrubbers for sulphur extraction has been prescribed to deal with environmental
standards, when emissions cannot be monitored effectively. The issue is in principle the same
with any type of health, safety or environmental regulation governing any type of business.
Work obligations and hold-up issues. We also find investment obligations in concession-
type contracts where there is no price regulation. For example, oil exploration leases often
prescribe certain work programs. Alternatively, the right to explore all or part of a particular area
has to be relinquished by the holder of the lease, if she is not actively exploring for fuels. In other
cases, government may require that radio spectrum licenses be used or returned otherwise. These
provisions appear to be aimed at the possibility that private parties bid for concessions so as to
restrict supply or hold up development of an integrated system and thus exercise some level of
market power.5 The possibility of hold-up problems is, of course, precisely the reason to give
governments the right to interfere with property rights, i.e. the very reason for having concessions
in the first place. The work obligations are in these cases ways of defining conditions for
termination to cope with potential hold-ups.6
From contract award to financial closure. After contract award, financiers may insist on
contract adjustments to render projects financible. Completing financing arrangements before
contract award tends to be prohibitively expensive. Careful contract design can make financing
fairly easy.  In the best of cases, certain highly standardised contracts in the heydays of
independent power projects in the US, reached financial closure within a few weeks after contract
award without material change to agreed terms. But in many other cases where contracts are not
4In an Argentine gas pipeline BOT from the early 1980s, COGASCO, a certain method for extracting propane,
butane and other gas liquids from the gas stream was prescribed. The private concessionaire found a more efficient
way to extract liquids and was later accused of breach of contract inter alia for this reason
5 Of course, an oil field may not be exploited because the company simply wanted to buy an option to explore later
rather than trying to gain monopoly power.
6 Concessions are one way to grant rights to a "governmental" authority to terminate or suspend property rights.
The notion of hold-up problems is central to an understanding of concessions. There are a number of cases when
transactions have to happen in bilateral monopoly settings, where there is only one buyer and one seller, or in
situation that approximate this state of affairs.  In those cases, particularly when comparator prices from
functioning markets are lacking, the transactions may be held up by parties trying to extract maximum rent. To
prevent or reduce such wasteful bargaining it may be socially useful to allow limits to be imposed on bargaining -
at the extreme the option of expropriation.



Bidding for Concessions                                                              Page 5
well designed, financial closure may take years to negotiate and the contract may be materially
changed.
Incompleteness of contracts.   All these cases create the possibility of future re-
negotiations. Careful drafting is necessary to create contracts that are highly re-negotiation
resistant and that contain mechanisms to adjust to changing circumstances without significantly
undermining the original terms of the contract award. Unsurprisingly, in practice the definition of
specifications is one of the most problematic, contentious and time-consuming aspects of many
concession contracts. Even with the greatest care one may forget aspects of a problem and
complete consideration of all possibilities (including genuine innovation by bidders) may be just
too cumbersome and costly - not least in lawyers' time. Contracts are thus not likely to cover
comprehensively all possible future occurrences.7
Incentive schemes
Incentive systems consist of cost-sharing and pricing arrangements as well as sets of special
penalties or incentive payments in case certain performance standards have or have not been
achieved. In addition, they comprise bonding devices, for example performance bonds, and
insurance arrangements. The incentives are to be set and aligned such that the concessionaire
manages the risks and opportunities she is facing in a way that is in the interests of the conceding
authority. The following discussion just highlights a few major points related to the sustainability
of contracts.
Risks outside the concessionaire's control. Risks that the concessionaire cannot control or
assess better than its customer(s) should generally not be shifted to the concessionaire. When
both concessionaire and customers are similarly able or unable to control or assess risks, then
desirable cost-shifting depends on whether consumers or investors have the lower cost of risk-
bearing. When uncontrollable risks are shifted to customers, away from the concessionaire, net
costs to customers do not increase (assuming equal costs of risk-bearing for consumers and
investors), but the likelihood of contract re-negotiation is reduced. For example, the cost of
purchases over which the concessionaire has no control are generally passed through to the
concessions customer(s) via the price adjustment formulae.
The principle is widely accepted, albeit the determination of what is or is not under a
meaningful degree of control of the concessionaire can give rise to intensive negotiation.  In
practice, hybrid approaches are often used. For example, the risk of general price inflation may be
passed to consumers. This makes sense when it is unclear to what extent the concessionaire can
control costs. By passing through a general benchmark for cost increases, namely inflation, the
concessionaire retains the incentive to beat the benchmark by making best efforts to control costs
relative to the situation where the remuneration of the concessionaire is set by a rate of return
7 Transaction costs (development activity, negotiations etc.) for concession-type projects tend to be quite high as it
is. Where concession arrangements are reasonably well understood transaction costs may be in the order of 3-5%
of total project value. In countries, where the concept is new, initial transaction costs may be above 10% of project
cost (Klein et. al., 1996)



Bidding for Concessions                                                           Page 6
applied to its cost-base (rate-base).8 At the same time the concessionaire need not ask for
excessive risk premia that would be required if all cost risks were shifted to her under a fixed-
price scheme. The properties of various pricing arrangements have been extensively discussed in
the literature on regulated industries ranging from cost-plus type pricing to fixed-price contracts
(see Armstrong, Cowan and Vickers ,1994, and Laffont and Tirole, 1993).
In an application of the general principle, Engel, Fischer and Galetovic (1996) have argued
that, where demand risk cannot be controlled or assessed by concessionaires the latter should not
be exposed to it. This could apply, for example, to traffic demand for certain toll roads or power
demand when the concessionaire supplies a monopoly with its own competing power generation
(the case of many independent power projects or BOTs). An optimal scheme would then not
auction off the road or the power plant on the basis of the lowest toll or price of power but on the
basis of the least present value of revenue. The concession would end when that level of revenue
were reached. If contract re-negotiation would ever become necessary, it should be comparatively
easy to determine the amount of revenues that have not yet been earned by the concessionaire and
this would determine optimal compensation payments limiting the ability of negotiating partners
to extract excessive payments during re-negotiations. This scheme is being applied to the Chilean
road concession program. A similar scheme has de facto already been used in the case of the
Dartford tunnel in the United Kingdom. The project was financed with debt only. Therefore, it
was only natural to specify that the concession would end when the debt is repaid. The latter
considerations did not play a major role in the design contrary to the Chile case as it remained
open to what extent the concession would be debt-financed.
Cost-sharing and bidding intensity. A particular aspect relevant to competitive bidding is
the relationship between pricing or cost-sharing rule and the intensity of expected competition
(McAfee and McMillan, 1988). At one extreme pure cost-plus rules render competition
meaningless. If concessionaires face no possible exposure in the case of cost increases for
whatever reason, then they would all bid low and later claim cost increases. As soon as
concessionaires have to share a little in cost increases the most efficient firm would be selected in
a competitive auction as it could make the lowest bid.
When much of the cost is shared with the customer even not so efficient firms can make
fairly low bids putting pressure on the most efficient firm and more risk averse firms will consider
bidding. For example, if the cost (incl. desired profit) of the high cost firm are 200 and the cost of
the low cost firm are 100, then under a fixed-price bid the low cost firm would win with a bid of
199, which just beats the high cost firm that bids 200. If the consumer were to share costs 50-50,
then the winning bid would be 99 as the low cost firms just beats the high cost offer of half of
200, i.e. 100. Consumers would pay half the cost of the winning firm i.e. 50 plus the bid price of
99 yielding a total payment of 149 from the customer(s) to the concessionaire compared to the
199 otherwise.
In this sense a higher degree of cost-sharing renders competition more intense and beneficial
to conceding authority and/or customer(s). This needs to be balanced against weaker incentives
to control costs. Consequently, one would advocate fairly generous cost-sharing parameters for
' In the beginning of the 20th century many concessions had no inflation indexation. When price levels began to
rise in many countries, concessions required adjustments, which de facto often led to nationalisation of some type
as private concessionaires went bankrupt given the contracted prices.



Biddingfor Concessions                                                          Page 7
high risk, complex projects and fixed-price arrangements for "standard" ventures. For example,
Eurotunnel issued the main construction tender with cost-sharing, whereas natural gas fired
independent power plants might be bid on the basis of the lowest present value of revenue.
In practice, many companies tend to favor more cost-sharing and conceding authorities tend
to pursue arrangements close to fixed-price contracts. This is largely due to concerns about weak
incentives for cost control on the side of the authorities and the corresponding desire to be able to
shift costs to others on the side of the firms. Rarely is the effect on bidding intensity considered
by governments. As for companies we should expect low cost firms to argue for approaches
closer to fixed price rules and high-cost companies for more cost-plus ones.
Post-award contract adjustments and bonding mechanisms
Because even the best designed long-term concession contracts will usually have to be
adjusted some time during their life, sound contracts contain mechanisms to deal with such
adjustments. They may specify the conditions, under which re-negotiation may take place and
principles on which it may be based. In particular, pricing arrangements may be reviewed if
unforeseen shocks occur or otherwise at certain intervals, which may be fixed or determined by
the parties to the contract. In this respect concession contracts are no different from utility
regulation more broadly. For example, prices in French water concessions may be re-negotiated
when unforeseen events occur (imprevision) or after a certain period of time, say 5 years. Utilities
in the United Kingdom may see prices adjusted via so-called interim assessments following
unforeseen shocks or during planned price reviews, for example every five years.
Service continuity and performance bonds. Re-negotiation occurs in a quasi-bilateral
monopoly setting. Concessionaires can only negotiate with the government and governments may
find it difficult to turn to alternate concessionaires.  Governments will often be reluctant to
terminate a concessionaire, because they are afraid that basic services will suffer, for example
water supply may be interrupted. To deal with such concerns the concession arrangement can
contain an obligation for the concessionaire to continue providing service until a new one has
been chosen, for example, in Colombia this obligation is contained in a general law governing
inter alia concessions.
However, governments still worry whether concessionaires will in practice fulfil their
obligations. Performance bonds have proven valuable to prevent partners from walking away
from a contract. In this way, performance bonds limit bargaining options after contract award. A
case in point is a recent dispute in a water concession in Latin America, where several partners in
a concession consortium walked away from the concession, when difficulties with the conceding
authorities became unbearable. But key players stayed in and tried to make it work, not least
because of the risk that a rather substantial performance bond would be called.
Government guarantees.  Concessionaires on the other hand try to bind conceding
authorities by providing for international arbitration under conventions, which make arbitral
awards enforceable. In addition, they may ask for special payment or performance guarantees to
ensure that the relevant counter party is able to pay when required.
III. To AUCTION OR NOT TO AUCTION?



Biddingfor Concessions                                                        Page 8
To get the best deal should the contract be auctioned off or negotiated?  Advocates of
negotiation tend to argue that a formal competition may take too much time, that costs of
preparing bids may be excessive and that innovation may be discouraged. Proponents of
competitive bidding tend to argue that there are ways to address many of these concerns without
sacrificing the bidding process. In addition, with competition the conceding authority may get a
better deal and transparency of the process may be enhanced rendering a deal more sustainable
politically. Additional considerations apply when considering whether to re-bid a concession,
because of the incentives for investment and maintenance that the incumbent faces.
Speed
It is true, of course, that implementation times can be cut by immediately awarding
contracts rather than going through a bidding process. Some of the early fast-track power
projects in the Philippines are illustrative. Sizeable power projects were completed in less than a
year. The resulting costs were a high, over 13 cents/kwh compared to 5-7 cents for later plants
that were competitively bid. However, this was still much cheaper than the cost of not having the
electricity available, which was estimated to exceed 50 cents/kwh.
But even if a key goal is speed, some preconditions should be fulfilled. One needs a list of
reputable concessionaires to whom to turn. The project and contract have to be well defined.
Some negotiation will be inevitable. Finally, one needs a fallback option in case the first chosen
company drops out or is not suitable for some reason and also to make negotiation halfway
meaningful. If alternatively one were to organize a quick competition among three or four
reputable companies one might lose a little time, but not very much, unless one is prepared to
heavily compromise on price by simply going to a company with a fairly open ended or generous
contract. In that case one would essentially rely on the reputational interest of the company to
limit price and obtain decent performance.
The costs of bidding
It is also true that the costs of preparing several bids may be prohibitively large relative to
the contract amount. For example, competitive bidding for a very small water utilities supplying
each just a few thousand customers may not justify the transaction costs of the process. One
option is then to pool municipalities and have them auction a single larger concession. Such
pooling, albeit normally without bidding is widely practiced among French municipalities' water
systems. A second widespread option to limit the costs of bidding is to limit the number of
bidders through a short listing procedure. Often just about four bidders are selected among those
technically and financially qualified. Alternatively one could select, for example, the four bidders
willing to offer the highest level of performance bonds and then turn to bid on the main bid
criterion. That would ensure that the most confident and creditworthy parties participate in the
final bid.
Finally, part of the costs of bid preparation may be shared by the consumers, who benefit
from more intensive competition. Such sharing of bid costs of up to 50 per cent is generally
allowed under the UK's private finance initiative and has been used in the case of Eurotunnel and
Athens airport. The shared bid costs are included in the total costs to be recovered from
consumers or the conceding authority. The argument is in the spirit of the one presented earlier,
namely that cost-sharing may intensify bidding competition. In any case, consumers eventually



Bidding for Concessions                                                      Page 9
pay for bid costs through tariffs under any system, but they may benefit overall from more
intensive competition. The main benefit from such cost-sharing obtains in situations where the
number of bidders is raised from one to two. In other cases, where a reasonable number of
bidders is likely to bid anyway, the rationale for cost-sharing would basically be dependent on
risk-aversion of the bidders and would lower their costs of risk-bearing.
All the foregoing options assume that overall the costs of bidding are outweighed by the
gains from competition. It remains very hard to determine ex ante whether that is likely to be the
case. Better criteria to make such determinations would have high value.
Innovation
Private sector companies may present governments with unsolicited innovative proposals.
They might, for example, propose a totally new type of project that nobody had thought about
before or a new concept to solve a known problem. Competitive bidding schemes, which
essentially specify a problem to be solved and desired performance standards can leave much
freedom to the private sector to come up with new solutions. But sometimes new and helpful
problem definitions may be found by firms and new ways of defining performance standards -
often embedded in a specific project proposal.
If the conceding authority were to use such ideas to formulate a competitive tender, it
would discourage private firms from developing them in the first place. It is, therefore, in
governments' interest to protect the private firms' intellectual property embodied in unsolicited
bids. The problem is, of course, to know whether the apparently good idea is really good and
whether the deal proposed can be adequately negotiated by the conceding authority.
Several basic options exist to combine incentives for firms to develop ideas with the benefits
of competitive bidding. Chile's concession system allows the government to provide a bid
premium for good ideas embodied in proposals. Subsequently, the good idea may be announced
in a tender to determine, which firm can best implement it. This method has been used in a
Chilean toll road project. The method is close to another option, namely to hold a design
competition prior to writing the concession tender. Formal design competitions are, of course,
normal for architectural problems, but rare in concessions. Concession-type arrangements tend to
be designed by the conceding authority with the help of consultants and inputs from consultations
with industry. The consultants may be competitively selected, but there are no cases where the
design itself was selected through competition.
A promising avenue for combining incentives for innovation with elements of competition
has long been part of Spanish administrative law and was also included in the BOT law of the
Philippines. In both cases, when the conceding authority receives an innovative unsolicited
proposal it announces the broad nature of the proposal. Potential competitors then have 90 days
to come forward with an alternative proposal. The problem remains the comparison of proposals
generated in this way may be complicated and require a fair degree of discretion on the part of the
evaluating authority.
De facto, in many bidding processes bidders learn about competing bids while they are being
evaluated. Corrupt leaks are often expected by bidders. In such cases, special rules to protect
innovative ideas contained in a bid will have little effect.
Transparency



Biddingfor Concessions                                                       Page 10
Transparency of the award process and with it longer term political sustainability tend to be
enhanced by competitive bidding that is conducted under clear rules. However, firms argue
correctly that competitions are a sham and a waste when the rules of the game are not clearly
defined. Bidders would not want to enter competitions where winning is a function of political
discretion rather than a professional assessment of the merits of bids against published criteria.
Some firms advocate that conceding authorities resort to negotiated deals in situations
where the rules of the game have not been made clear in credible ways. This would attract better
industry interest and de facto constitute a better learning process for the conceding authority than
an ill-conceived attempt to organise a bidding competition. There may be merit to the argument if
the government chooses a reputable company to deal with. However, that may not happen. In
any case, if the government really is intent on learning, it is hard to say why that could not take
place in the context of designing a competition.
Transparency is another word for limiting government discretion.  For long-term
sustainability of projects firms should support transparency. However, some short-run profit
opportunities may have to be sacrificed in the process. Insistence on transparent rules, in
particular competitive award procedures, is thus a reasonable way of selecting both good
governments and firms who are interested in the long term.
Bargaining strength
A key point of competitions is, of course, to improve the bargaining power of the conceding
authority. Precisely by submitting to clear bidding rules instead of negotiating, the conceding
authority is likely to elicit the best possible deals from firms. A fair amount of theory and
evidence appears to support this view (Bulow and Klemperer, 1994; Kwoka, and Domberger et
al., 1994).
What, de facto, weakens the power of bidding in the case of concessions is the fact that the
choice of winners may require a fair amount of discretion. The more discretion is unavoidable,
the weaker the case for bidding relative to negotiation becomes, and the more the competition will
start looking like a form of competitive negotiation. The need for discretion arises from the
difficulty of comparing and scoring bids. Bids for concessions tend to vary on many dimensions.
First, through a pre-qualification procedure, qualified reputable bidders need to be chosen.
It may not be specific to a particular bidding but function like procedures to get on a pre-
approved vendors list. While certain criteria can be specified such as technical experience and
financial strength, there is also value in making discretionary judgments about future
developments of a potential concessionaire. For example, among the interested bidders may be
an experienced, financially strong public enterprise from another country. Its current strength
may face major challenges if certain support mechanisms such as subsidies or special protectionist
measures provided by its home government were to be withdrawn in the future, which in turn
might raise the risk of relying on this company.
Second, the bids for concessions will vary on many dimensions, which need to be compared
and weighed against each other. The more dimensions there are, the more discretion the
evaluators have to determine a final ranking. This problem was mentioned before for the case of
comparing unsolicited with rival bids. In a regular competition the problem of potentially
excessive discretion can be reduced somewhat by using a two-stage bidding system. In the first



Biddingfor Concessions                                                           Page 11
stage technical bids are received. Following clarification with bidders, the various bids would be
evaluated and a determiination made on which of them meet the performance requirements of the
tender. Ideally, significant technical differences among responsive bids could be valued, for
example, the cost that different technologies impose on the environment. The second round of
bidding would then be just on the basis of a single quote on a single bid parameter, for example
price or the level of subsidy - adjusted for any differences arising from valuations at the first stage
of bidding. Discretion in such a system still exists, but evaluators do not know a crucial bid
parameter until the end of stage two. Their leeway for abuse is thus reduced. In practice it may
be crucial to have second stage bids opened publicly with auditors and bidders present.
But with the best of efforts there will remain cases where comparisons among bids are just
very complex and where de facto some form of competitive negotiations will take place. Bid
clarifications after bid submission may start to resemble negotiations or there may be actual
parallel negotiations with several bidders.  Alternatively, there may just be one principal
negotiation, but with a fallback so that the conceding authority can credibly threaten to terminate
negotiations with a particular party and not be at the mercy of a single bidder . Sometimes the
difficulties of comparing different complex concession proposals may be such that the conceding
authority reverts to prescribing basic technical parameters, for example, location and technology
in the case of power projects. This has been the reaction of the Thai government recently to its
difficulties with evaluating numerous heterogeneous offers for independent power generation.
One way of limiting the scope for contract abuse is the use of benchmarks for performance.
Suppose it was easy to define a benchmark price for power, say 6 cents/kwh. Then one could
simply use this as a maximum price in negotiations. However, this method will be highly imperfect
in practice for most concession-type arrangements, because general benchmarks tend to be
unreliable. Pakistan has tried it for power projects, but political debate of allegedly excessive
profits under this scheme may undermine its viability.
Basic policy bias in favour of competition
Overall, it is, therefore, not entirely straightforward to decide whether to auction or
negotiate a particular concession. When the conceding authority is a private company operating
in a competitive market, then there will be strong disciplines on it to prevent abuse of discretion.
Regulated monopolies and government authorities on the other hand are not subject to strong
market disciplines. Their scope for misusing discretion is greater. It is, therefore, more important
to bind the hands of such conceding authorities by imposing clear rules on the award process. By
limiting discretion some flexibility may be sacrificed in the interest of sustainable deals.
As a result most governments have started to adopt guidelines, laws or regulations, which
require competitive bidding as the favourite method of concession award. 9 Yet, at the same time
they allow for exceptions on well argued grounds of need for speed, excessive transaction costs
and protection of intellectual property rights. Examples are the guidelines for the private finance
initiative in the United Kingdom, similar guidelines in several Australian states, the concession or
BOT laws of the Philippines, Hungary and Chile. In some cases, for example in Oman,
negotiations are excluded as an option under the Sultan's privatization decree. In others such as
9 The association of national independent energy producers in the United States (NIEP) recommends competitive
negotiations for award of independent power plants by regulated utilities (NIEP, 1991).



Biddingfor Concessions                                                         Page 12
France, conceding authorities used to be entirely free to chose the method of award. However,
partly in reaction to concerns over corruption there are now some basic rules in France that at
least require conceding authorities to announce that they want to award a concession and thus
provide interested firms with the opportunity to bid.
Re-bidding
The longer a concession lasts, the less the initial rounds of bidding will affect the overall
terms of the concession over its full life. Those terms will be strongly affected by periodic re-
negotiations or price reviews, which are not settled by competition under standard concessions
(Williamson, 1976). It has been suggested that competition could be brought to bear on the issue
by re-auctioning a concession periodically. This would greatly limit the potential for exercise of
market power by concessionaires.10 Edwin Chadwick proposed this solution to the natural
monopoly problem in 1859. Harold Demsetz resurrected the notion in 1968. Re-bidding for
concession-type arrangements is consequently sometimes called a Chadwick-Demsetz auction.
Indeed, if contracts can be well written and re-bidding is practical, the natural monopoly problem
can be tackled effectively. Price regulation per se may no longer be necessary. In this view re-
bidding may help with contract adjustment. Of course, re-bidding would also help re-award a
concession that has been terminated to deal with a hold-up problem.
The role of differing information and bidding biases. Re-bidding is a practical option,
when assets are not specific to the concession. For example, garbage collection franchises may be
re-auctioned periodically. If the incumbent loses, she can simply transfer assets (trucks and staff)
to another purpose or sell them. Similarly, bus routes could be auctioned repeatedly. Studies
suggest that auctioning of short garbage collection concessions is more economical than either
allowing free entry (with garbage trucks chasing the same consumers) and long-lasting monopoly
arrangements (Bartone, Leite, Triche, Schertenleib, 1991).
Problems arise when the concessionaire's assets are specific to the concession and are better
understood by the incumbent than the challengers. For example, water pipes cannot normally be
dug out and used elsewhere economically. In this case special incentive problems arise, which
complicate re-bidding. These have been best analyzed by Laffont and Tirole (1993). Concession-
specific assets may either be transferable to the winner of a re-bidding, for example the physical
infrastructure, or they may just stay with the incumbent, for example managerial know-how about
the concession. When assets are transferable any investment or improvement by the incumbent
would benefit the new winner. The incumbent would thus have less of an interest to invest or
maintain efficiently than if there was no re-bidding. On the other hand, when assets are not
transferable they would give the incumbent an absolute advantage during the re-bidding. In the
former case, the incumbent should be given a preference and in the latter a bias against her should
be established in re-bidding. How these effects balance is an empirical matter.
In practice, one might speculate most assets can actually be transferred. Routinely new
winners employ key staff of the incumbent and thus appropriate much of the human capital
specific to the concession in addition to the physical ones. It might, therefore, be argued that a
bias in favor of the incumbent might be advisable. In those cases where re-bidding of complex
10 Recall that concessions are only needed when there are monopolies to be awarded. Otherwise free market entry
should prevail.



Biddingfor Concessions                                                               Page 13
concessions occurs we do indeed observe such biases. In France, concessions have traditionally
been awarded at the complete discretion of the conceding authority. De facto, this has meant that
concessions were usually re-awarded to the incumbent.
In Argentina re-bidding is mandatory for the Buenos Aires 99-year electricity distribution
concessions initially after fifteen years and then every ten years. Bidding is on the value of the
concession assets, while the price remains as reviewed by the regulator. This is de facto a system
with an infinite preference for the incumbent. The incumbent can always retain the concession by
bidding an outrageous amount, which she pays to herself. More likely, of course, the incumbent
will bid the amount she feels justified and if somebody wants to pay her more for quitting, so
much the better. The benefits of the greater willingness to pay of the new winner are all
appropriated by the concessionaire, not by the consumers, unless regulators decide to pass some
benefits to consumers in reaction to a successful challenge to the incumbent.
A market for corporate control of concessions. The Argentine electricity concession re-
bidding scheme is similar to allowing take-over bids. In a sense the scheme makes take-over bids
mandatory every ten years. Take-over bids would extract greater value for shareholders given a
certain pricing policy.11 They would benefit consumers if regulators were to take the successful
bid as evidence that prices could be lowered more. This, of course, might dampen the enthusiasm
of potential bidders. Nevertheless, the successful re-bid can provide extra information to the
regulator. Even requiring that the concessionaire quote some shares on the capital market may
help. Some evidence in this regard is provided by the dispute about retail power prices in the
United Kingdom 1995. The electricity regulator, Stephen Littlechild, changed his opinion on
future prices, because a hostile take-over bid prompted a defence revealing that the electricity
distributor had a stronger financial position than the regulator was made to believe.
If the benefits of re-bidding can also be obtained by requiring concessions to be listed on the
stock exchange (Mayer and Jenkinsen 1997) and by allowing take-over bids, then it is hard to see
how mandatory periodic re-bidding schemes of the Argentina power concession-type could
improve on this. They may only be justified, if there were otherwise no effective take-over
mechanism.
Re-bidding as a means to reduce regulatory discretion. Yet, there may still be a role for
re-bidding. After all, one reason for allowing or requiring challenges to the ownership of a
concession is to provide regulators with better information for price setting. As argued before, if
the market for corporate control yields such information, the regulators may use it to adjust
prices. However, if it is at their discretion to do so, firms might be reluctant to stage take-overs
and would figure in a discount anticipating regulatory reaction to the bid including a risk premium
to take into account the degree of discretion of the regulator. There is nothing much one can do
about firms taking into account likely responses by the regulator. In fact, it is good that they do,
because they should be satisfied with the business even if the regulator passes part of the
efficiency gains to the consumers.
" For this to work the "concession" should be treated like a firm, i.e. its full balance-sheet (assets minus debt)
should be bid for rather than only the assets. In fact, it may be best to think about the concession simply as a
regulated firm, where govermnent retains rights to re-take ownership or change ownership under certain
conditions. This is also possible in regulated utilities in the US. Witness the municipalisation or de-
municipalisation of water utilities.



Bidding for Concessions                                                                Page 14
However, it might be possible to reduce the risk premium for regulatory discretion by a
formal system of re-bidding. To achieve this, one might organize the following re-bidding
scheme. To ensure that creditor and investor interests are taken into account adequately, one
could value the company on the basis of its debt and stock market capitalisation. Bidding would
first be on the net worth for the firm. If more than one bid is higher than some pre-determined
12
price the bidding would switch to the lowest price to consumers . A bias would be provided in
favor of the incumbent, but not an infinite or discretionary one. Instead one could give, for
example, a 10 per cent preference such that the new bidder only wins if she can underbid the
incumbent by more than 10 per cent.  Such systems are used in bidding for more traditional
contracts for equipment and civil works and have also been used in radio-spectrum auctions in the
United States. This scheme would thus eliminate a fair degree of discretion on the part of
regulators. A scheme of this type has been discussed as an option in reform debates for the
Chilean water system.
Re-bidding to strengthen reputational mechanisms and to limit government discretion.
If one believes that concessions should be awarded competitively, then one should also re-
award them competitively for the same reason, in particular, to limit discretion on the part of
governments. The real issue is whether there should be a re-awarded in the first place. That, of
course, is the very essence of concessions as property rights with special termination options for
government.13  Termination is a threat to the concessionaire and should ideally be used to
strengthen her incentives to behave well so that the threat may never be exercised. In this sense
the design of termination and re-bidding options should be aimed at creating the strongest
possible incentives for firms to develop and maintain reputation.
To achieve this, governments or regulators should allow bids only from reputable
companies. Some form of pre-qualification is thus likely to be required.14 Companies that are
interested in bidding for concessions in the future thus have an interest in maintaining a good
reputation. Such interest in reputation appears to be quite effective in reducing companies'
incentives to re-negotiate concessions capriciously. Zupan (1989) finds in a study of 3000 cable
TV franchises in the US that opportunistic re-negotiation appears to have taken place in only 60
cases.
Assessing a company's reputation is often a subjective judgment.  When tasks are
contracted out by firms operating in competitive markets, the firm choosing the "concessionaire"
has a fairly strong interest to judge reputation efficiently. However, where governments or
regulated industries issue concessions such discipline may be absent. The issue is then first
whether to allow government agencies to assess reputations. At one extreme procurement rules
12 Such a bidding scheme has been proposed by Eduardo Bitran for water concessions in Chile inspired by a similar
scheme for tollroad bidding.
13 Note that governments tend to have emergency rights to confiscate all sorts of property e.g. houses, cars or food
in times of war. One may again interpret this as a way of dealing with hold-up problems.
14 De facto this is also the case in other markets. Over a decade ago a large construction and housing company,
Neue Heimat, went bankrupt. It was purchased by a private individual with neither relevant business experience
nor any noteworthy wealth for I German mark. Creditors of Neue Heimat saw to it that this transaction was
undone.



Biddingfor Concessions                                                      Page 15
governing the US department of Defence make it almost impossible to take reputation into
account. At the other extreme French mayors have almost unlimited discretion to evaluate
concessionaires. What would be required is a mechanism that can take "soft" information into
account better, as rating agencies do when they evaluate capital market participants.
IV. How TO AUCTION
Once it is decided to use an auction to award or re-award a concession, the issue arises
what auction mechanism one should use. Mechanisms may differ on various dimensions. This
section will consider the choice between first and second price auctions as well as sealed bid and
open formats. Then the issue of sequential vs. simultaneous auctions is introduced.
First price versus second price auctions and sealed versus open bids
Auction formats.  Standard auction design for concessions is a first-price sealed bid
auction. Bidders submit sealed envelopes containing their offer. Bidding may have one or two
stages. In stage one the technical parameters of the bids are made comparable. In stage two only
the main offer on the core bid parameter is submitted. This may be a price, a level of subsidy, a
payment for net worth or any other appropriate parameter. In the following the discussion simply
talks about price. Alternatively the complete bid may be submitted in a single stage.  The
envelopes are opened, bids are made public and the highest bidder wins. Under one-stage bidding
it may not be immediately obvious who has won, because bids first have to be compared and
evaluated on all relevant dimensions. These approaches parallel those for bidding for civil works
and equipment contracts.
However, recently some other auction methods have been tried and some problems arising
under sealed bid auctions have given rise to reconsideration of their merit. In New Zealand
second price sealed bids were used to auction of licenses for radio spectrum. Under a second
price auction the process of bid submission and opening is like under a first price sealed bid
auction, but the winner pays only the value offered by the second highest bid.
Design of the radio spectrum auctions in the United States was much inspired by economic
theorists. The very idea of auctioning spectrum was floated decades ago by Ronald Coase. The
auction design was developed by the FCC with the help of game theorists. Open ascending bid
auctions were used, much like in auctions for antiques and many other goods. In open auctions
bids are made technically comparable. Then the real bidding starts. In multiple bidding, rounds
bidders raise their bids in response to others until only one bid, the winner, is left over. The
winner pays the last price that she offered.
The choice of auction method is affected by arguments about
* political sustainability of the outcome;
* robustness of firms' bidding strategies; and
* options for collusion among firms.
All these elements combine in determining whether a particular auction design yields value,
how that value may be distributed among bidders, consumers and the government and whether the
deal will last.



Biddingfor Concessions                                                         Page 16
Political sustainability. Bidding for concession-type arrangements is often among a few
players only and price offers can differ dramatically.  Winning bids for concession-type
arrangements have often been several hundred million dollars higher than the second highest one,
for example, in case of the Mexican railway auctions (North-east concession) or the Peruvian
phone system privatization. Such hugely differing bids tend to render second price sealed bid
auctions politically unsustainable. In one extreme case in New Zealand's radio spectrum auctions
the first bid was NZ$ 100,000, the second only NZ$ 6. This outcome created obvious political
problems under the second price rule.
Open bidding processes, on the other hand, do not reveal what the winning bidder might
have been willing to pay. Bidding stops when the winner offers just a little more than the second
highest bidder. De facto, the winner thus pays more or less the second highest price but nobody
sees how  much more could have been obtained.  This would tend to reduce political
complications unless information about willingness to pay were leaked by staff of the winning
bidder.
From the point of view of political sustainability sealed bid second price auctions are clearly
dangerous when there are only a few bidders as is typical for concessions. If there were many
bidders the likelihood of big differences arising between the first and second bid would be much
lower, but the transaction costs of the process might be prohibitive.  First price sealed bid
auctions and open auctions can both yield reasonable sustainability, because in one case the first
price wins and in the other the first price is not known.
Guessing competitor strategy. Under first price auctions bidders need to assess what the
likely bid of their rivals might be. The better they guess that, the less of a premium they need to
bid so as to win. If their guess is perfect, they can bid just above the second price like in an open
auction and still win. For example, some bidders take multiple envelopes to the bid opening. If
they find out they are the only bidder or if their most dangerous competitors do not show up, then
they will hand over the low bid envelope.
The more risk averse bidders are, the more likely they will bid "too high" just to make sure
they win. Under second price auctions they just bid what they think the concession is worth and
do not need to care about others' valuations. They can thus focus on valuing their own bid.
Consequently, first price auctions render bidding more complex for bidders thereby increasing the
risk that clever firms rather than efficient ones win. At the same time government revenue should
go up under sealed bid first price auctions relative to sealed bid second price ones if bidders are
risk-averse.15
Guessing the right value to bid - the winner's curse. In the case of a standard equipment
contract the bidders may more or less know what their own costs are and can then calculate the
best offer. In many concessions bidders may need to value the right to the concession, which
depends not just on their own skill but on factors affecting all bidders, for example the
willingness-to-pay of consumers and the future behavior of regulators. Cases where the bid value
depends only on characteristics of the bidder are called private value auctions. Cases where the
value depends on factors that affect all bidders are called common value auctions.
15 For more technical expositions of these points see McAffee and McMillan (1987), Milgrom (1989) and Riley
(1989).



Bidding for Concessions                                                              Page 17
Different bidders have differing information and abilities to value a concession. The
outcome could, therefore, be that the most optimistic bidder rather than the most efficient will win
the auction, which would lead to failure of the winner, pressures for re-negotiation and excessive
costs. This is called the winner's curse.16
Consequently, bidders need to assume in their bids that they may be over-optimistic and
adjust their bids downwards. To make sure they do not lose they have to assume that they are in
fact the most optimistic bidder and discount the bid accordingly. If they do not they will not
survive for long in an industry based on common value auctions. Inexperienced bidders often fall
prey to the winner's curse, which is a well established phenomenon in experimental settings. Oil
companies, on the other hand face the winner's curse when bidding for exploration or production
licenses. Many oil companies have been able to survive through a mix of prudent bidding and, of
course, on the basis of superior geological assessment i.e. private value aspects of oil mining
licenses.
When governments select serious, experienced long-term players to bid for concessions,
these will adjust their bid prices conservatively so as not to fall prey to the winner's curse. They
all might bid more aggressively, if they had better information about the value of the concession.
Open bidding gives them some better information, because in open bidding they see what others
are willing to bid. If a pessimistic bidder thus sees that everybody is still bidding when she
thought of quitting, she might continue to bid. On the other hand, when most bidders start to
drop out of the bidding it is time to revise one's valuation downward. For prudent experienced
bidders the winning bid should on average go up under open bidding and the likelihood of an
overoptimistic bid should be reduced. Thus, governments should expect better and more
sustainable deals on average. For this reason, the Federal communications Commission of the
United States chose an open bidding process for auctioning rights to use various bands of the
radio spectrum.
In general, governments should provide as much relevant information to bidders as possible
so as to render bidding more aggressive. Sometimes more information may reveal weaknesses in
a conccssion proposal and would thus unequivocally reduce bid prices. But in such cases the
winner would have had to re-negotiate anyway later on.
Collusion. First price auctions may be a little better protected against collusion by bidders
than open auctions. Suppose there is a bidding cartel among some of the bidders. In an open
auction they can see when one of them breaks ranks and bids more aggressively than agreed.
Other members of the cartel can then immediately retaliate by also bidding more aggressively.
The fear of such retaliation strengthens discipline in the cartel. In sealed bid auctions, retaliation
can only occur if there is repeated bidding for concessions with similar players involved. That is,
of course, often the case, currently most clearly in water concessions.  It is thus not clear that
sealed bid auction really constitute better protection against cartels than open auctions in such
cases.
16 If winners were to expect that they can get away with re-negotiation, then they would in any case have no
incentive to bid responsibly. Such "lowballing" bidders - called "coyotes" in Mexico - would simply bid low in the
hope of making up later in re-negotiation. As has been discussed already, for bidding to be meaningful, failure to
comply with terms of the bid must impose costs on the bidder. The winner's curse thus seriously threatens the
winner in a meaningful auction.



Bidding for Concessions                                                          Page 18
In addition, a number of sealed bid auctions are, de facto, open. Widespread corrupt
practices make it possible for bidders to learn about competitor bids before bid award. They can
then adjust their own bids accordingly. Such practices can best be guarded against under two-
stage bidding. The price envelope is then handed in on the day of bid opening. Deadlines tend to
be set. Bidders try to hand over the envelope just before the deadline so as to reduce the
possibility that the envelope might secretly be tampered with and to make use of any information
that may transpire until the last moment. Bids are then opened publicly with auditors present who
ensure that those who open the bid read it out correctly and do not suppress or distort any
relevant information.
Such safeguards were, for example, used in the recent bidding for an electricity concession
in Gabon. When the government auctioneer opened the price envelopes he noticed that the
government's preferred bidder was not the winner. The auctioneer then suspended bidding
without announcing all the prices and consultations in government took place on what to do. Yet,
later bidders were reconvened and the opening continued. Because, there was an impartial
observer simultaneously reading the envelopes next to the government auctioneer, it could be
ascertained that the final bid award was made correctly. Most likely the government came to the
conclusion that deviation from the correct award process would harm its reputation and ability to
finance the concession. Had there been fewer safeguards the outcome might well have been
different.
-While sealed bid auctions can thus be rendered somewhat collusion-proof, open auctions
can also be "proofed" a bit. For example, in an open auction bidder identities may be kept secret.
Bidders need not be in the same room and can bid remotely. Reputable auditors can supervise the
integrity of the process. However, it remains true that cartels can still retaliate a bit better against
defectors than under sealed bid schemes.17
Reserve prices. When competition is weak, governments rnay use reserve prices to guard
against collusive low bids. It is useful to keep reserve prices secret so that risk-averse bidders pay
more rather than less. At the same time one needs to prevent arbitrary manipulation of secret
reserve prices by corrupt auctioneers. One way is to deposit the reserve price in a sealed
envelope with reputable auditors.
The use of reserve prices also tends to serve political aims, namely to convince the public
that state assets are not sold below value. This sometimes runs counter to sound use of reserve
prices. Particularly, when assets may fetch less than book value it is often difficult to set a
reserve price below book value. But these cases are, of course, politically tough to handle under
any circumstance.
Altogether it is thus not quite clear whether first price sealed auctions or open auctions are
preferable. In the private sector we often see some form of competitive negotiation, which in
principle operates like an open auction. For government procurement or procurement by
regulated monopolies it may be desirable to limit the discretion involved in competitive
negotiation. Broadly the following general arguments about the relative merits of open vs. sealed
bids might then hold. When competition is strong with many and/or diverse bidders then open
17 This is an instance, where some degree of in-transparency prevents collusion. While overall transparent rules
are valuable, their detailed design needs to watch out for such instances.



Bidding for Concessions                                                        Page 19
auctions might be preferable, because collusion is unlikely, anticipation of others' bidding strategy
is unnecessary and the danger of winner's curse would be lowered. As discussed before, in such
cases fixed price contracts are in principle relatively more desirable than cost-sharing contracts.
However, particularly when the number of bidders is small, first price sealed bid auctions may be
preferable to guard against collusion. At the same time, to stimulate bidding competition
contracts should have relatively higher cost-sharing between concessionaire and customer(s).
Sealed bids may also be preferable when bidders are risk averse and when bidders are very
different from each other, because then sealed bids may increase the bids placed by the winner.
Simultaneous versus sequential auctions
For the radio spectrum auctions in the United States a simultaneous open auction was used.
Bidders bid simultaneously on all areas where they wished to acquire a license to use a particular
frequency.   Areas were  auctioned  off simultaneously, because  there  can  be major
complementarities between them. For example, telecommunications firms might want to own
licenses in adjacent areas, because this might reduce the costs of building out the infrastructure for
wireless communication systems. If areas had been auctioned sequentially, bidders might have
acquired one not knowing that strong bidders were going to take a valuable adjacent one. Had
the winner known that she might have bid less for the first or not at all or for another area. By the
same token, simultaneous auctions only make sense when they are open. It is of the essence that
bidders are able to adjust bids in response to others. Therefore, the issue does not arise if one
wants a sealed bid format.
It is not clear that there are significant benefits to simultaneous, auctions in most
concessions. For example, in the case of the Mexican railway concessions it was discussed
whether to use simultaneous auctions for the major three rail concessions. However, in this case
bidders could not aggregate concessions, because any bidder could not win more than one
concession. Bidders just needed to value each concession and bid what it was worth to them. So
far simultaneous auctions for concession-type arrangements have not happened other than for
United States spectrum auctions.
Simultaneous bids might make sense if airport slots were auctioned that have to be
aggregated into routes. In such cases a simultaneous auction would allow the market to decide
how to aggregate pieces of a system most efficiently. Once such pieces are auctioned secondary
markets bear the burden of improving on the aggregation of concessions or licenses. Good
secondary markets would also solve the problem and do in any case carry the burden of re-
aggregation after the initial auction. However, there may be problems to acquire certain essential
licenses when some players do not want to sell as in the case of road construction when a
potential seller of part of a right-of-way plays hold-up games. As mentioned before, hold-up
issues may constitute the very reason for using concessions, i.e. property rights that may be
terminated by government.
V. WHO AUCTIONS
When all is prepared the auction has to be implemented. Depending on the nature of the
contract and the auction mechanism the auctioneer(s) may have more or less discretion.
Discretion will play almost definitely a role in evaluating bids. It is already practice in several



Biddingfor Concessions                                                      Page 20
countries to institute special independent review panels in case of negotiated deals, for example
under the British private finance initiative.
As discussed before much discretion remains even when evaluating fairly tightly structured
competitive bids. The bids vary on so many dimensions that there is no measuring rod (metric)
which allows a non-discretionary comparison among bids. Also, pre-qualification and short-
listing may well involve some judgment when the reputation and character of the bidders matter
and not only verifiable track record. It is thus important that the auctioneer (or panel of bid
evaluators) are at arms-length from political pressures and from bidders' interests.
The independence debate. How the often elusive goal of independence may be achieved
has been much studied, for example for the case of regulatory agencies (Smith and Klein, 1994).
Design issues are: How many members does the evaluation panel have? Who appoints them?
What organization can they come from when getting onto the panel? Who may they work for
afterwards? What is their tenure? Who approves their expenditure budget? Where do the funds
come from? How much budgetary autonomy do they have? How well defined are the procedures
governing the auction process? How public are the deliberations? What kind of consultation
mechanisms with bidders or members of the public may be in place? Will deliberations and
evaluation be in written form? How public will the decisions and the reason for them be made?
Will dissenting opinions be published? What kind of auditing mechanisms should be in place?
Typically, there is not too much debate about these matters when it comes to procurement
of concessions. The independence of the "judges" is rarely discussed as much as the evaluation
principles and the auction rules. However, in the case of concessions this is short-sighted given
the degree of discretion involved and the political prominence of many of the businesses involved,
for example water supply. Particularly, those who argue that reputation and character matter a lot
and that therefore tightly defined contracts and bidding mechanisms are not the answer should
advocate the institution of "independent auctioneers" to avoid conflicts of interest.
The role of the regulator in auctions.  Once one agrees on the need for independent
auctioneers for concessions, the question arises why one should not use the regulator to conduct
the auction, although not necessarily define the contract and auction format. The latter may still
be done by the conceding authority. If auctions are essentially a mechanism to improve
information for price review processes, then it would seem particularly appropriate to have the
regulator conduct the auction.
Furthermore, as discussed before, concessions exist, because the conceding authority, say
the government, wants to be able to terminate the concession under certain circumstances.  In
particular, the govermnent may want to deal with hold-ups or may just be generally dissatisfied
with performance, although it would be difficult to build an indisputable case in court. The
concession format allows termination without fault either when the concession has a fixed tern,
which comes to an end or upon suitable notice of termination by the government. In a sense these
powers are similar to those under fixed term labour contracts or "no-fault divorce" to come back
to marriage analogies.
Obviously, such contractual arrangements place major discretionary powers in the hands of
governments. To guard against abuse it would, therefore again be desirable to render the
conceding authority as independent as possible. However, it may not be advisable to mix the
functions of regulator and conceding authority, because regulators may have to arbitrate in



Biddingfor Concessions                                                         Page 21
disputes between concessionaire and government. Alternatively, such disputes could be left to the
courts and all powers over the concession could be left with the "regulator". For example, in the
United States, the Federal Energy Regulatory Commission has both licensing and regulatory
powers.
VI. Conclusion
The paper has reviewed issues arising in awarding concession-type arrangements. It
discussed issues of contract design, whether contracts should be auctioned off, how auctions
should be designed and who should conduct the auction.
Two key features characterize concession-type arrangements. First, they are long-term
contracts that require adjustment over time. Second, conceding authorities maintain rights to
terminate the contract to prevent hold-up problems. As referred to throughout the discussion,
economic theory has made contributions to various aspects of concession design and award. The
core issues are how to ensure that both conceding authority and concessionaire adhere to the
contract and behave in a reasonable spirit.
In a nutshell, to prevent unnecessary and capricious re-negotiation, concession contracts
should contain well thought-out performance specifications, well balanced incentives and risk-
sharing arrangements and strong bonding mechanisms leading the contractual parties to adhere to
contract terms. When concessions are issued by government authorities or regulated monopolies,
they should in principle be awarded through competitive bidding, except for cases where the need
for speed is extreme or where the transaction costs are high relative to contract value. Normally,
conceding authorities use sealed bid fixed price auctions, but there may be reasons to use open
bids more often. Importantly, whatever the method of award, the awarding authorities will need
to exercise significant discretion. Therefore, arrangements should be put in place, much more
often than is currently the case, to ensure that the agencies managing the award process are at
arms-length from all interested parties. Reasonably independent regulatory agencies could, for
example, be charged with conducting the award.
Many aspects of concession contract award could benefit from further analysis. For
example, it might help to provide better criteria on the exceptional cases when negotiated deals
might be preferable to competitive bidding. It would also be useful to have a more complete
investigation under which circumstances it might be preferable to use first price sealed bid
auctions as opposed to open auctions to award concessions. Clearly, it would help if one could
find better criteria on what kind of biases, if any, to incorporate in re-bidding processes.
Some fundamental issues have been neglected by theory. Both the design of reputational
mechanisms and ways to limit discretion of conceding authorities are of great practical
importance, but little guidance is available.
Finally, it would be interesting to see more work on which type of concessions, licenses or
permits can be made tradable and how. For "standard" concessions this relates to the market for
corporate control or the tradability of the concession title. More broadly, one could, for example,
investigate whether and how rights-of-way may be traded. This discussion would be closely
related to debates about tradable permits in general.



Bidding for Concessions                                                            Page 22
Fundamental to a study of concessions is adequate treatment of termination provisions and
their exercise plus, of course, all the mechanisms to prevent termination from being exercised
unnecessarily. In practice, when concessions are negotiated, termination is often the last thing
negotiators dwell on. Issues such as financibility of the deal tend to dominate, or the level and
structure of prices, or quality parameters. Exaggerating slightly one might say that investment
bankers care about being paid back, not about efficiency per se. In fac,t they generally like
monopolies i.e. exclusive rights. Lawyers tend to care a lot about details of the governing legal
system and legal enforceability, but not that much about well-designed incentives. Where
practitioners' incentives are thus deficient in dealing with the core issue of concessions, more
detached observers and theoreticians should have a better than average chance to make useful
contributions.



Bidding for Concessions                                                      Page 23
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Biddingfor Concessions                                                      Page 24
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