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PICKING the price at which to sell a public asset is a daunting task. The political stakes are high: this week Britain launched a review of such sales after claims that Royal Mail, the postal service, had been sold too cheaply. But the right price is hard to find, because privatisations are often one-offs. How much should, say, Portugal ask for TAP, the state-owned airline it has been urged to sell? Auctions are increasingly used to tease out the best price. Yet new research shows how collusion can corrupt auctions of public assets, so that the state is still short-changed.
Auctions have a simple aim: to reveal the bidders’ true valuation of the item being sold. Sellers then get the best possible price. By successfully revealing the maximum bidders are prepared to pay, auctions also allocate resources to those that value them the most. Auctions come in a wide variety. In a “Dutch auction”, often used to sell flowers and fruit, prices start high and gradually drop until a bidder is willing to pay up. A “Japanese auction” is a bit like poker: bids rise with each round and anyone who wants to win must bid every time. Vendors using auctions rid themselves of the headache of choosing prices and instead just pick the rules bidders must follow.
The choice matters, as a paper published last year, by Hongbin Cai and Qinghua Zhang of Peking University and Vernon Henderson of the London School of Economics, shows. The authors examine sales of public land in China. In the 1990s dissatisfaction with the private negotiations that allotted land to developers grew. The processes were murky and the prices paid were often suspected of being too low as local officials siphoned off bribes. So in 2004 the government announced both a crackdown on corruption and a new policy of selling land by public auction.
Local officials choose the auction rules. In Beijing and Shanghai they plumped for a zhaobiao or “sealed bid” sale. Across the rest of the country, two other types prevailed. One was a paimai, a familiar “English” ascending-bid auction: rival developers try to outdo each another, pushing up the price until only one bidder is left. The other was aguapai or “two-stage” auction. In the first stage, which lasts ten days, bidders can post bids anonymously on the internet. Rival developers see the current bid and the reserve price and decide whether to meet it, raise it or drop out. If after ten days more than one bidder is willing to pay more than the reserve, there is a second stage, in which an English auction is run between those who remain.
English and two-stage auctions produced strikingly different results. Collecting data for over 2,300 auctions covering 15 large cities between 2003 and 2007, the authors immediately spotted a suspicious pattern. In English auctions, bids were well spread, with some beating the government’s reserve by a big margin. But the first part of the two-stage auction clearly gave the bidders time to collude: in many there was little competition, with winning bids pitched at exactly the reserve price. If all the sales had been under English auction rules, government revenues would have been 30% higher.
Similar problems can arise when contracts are put out to tender. A paper by Kei Kawai of New York University’s Stern School of Business and Jun Nakabayashi of Tohoku University examines Japanese public building projects. They collected data on over 40,000 tenders from 2003-06 worth $42 billion (around 3% of national tax revenue). The Japanese government uses a first-price sealed-bid auction: builders write down their best price, and the lowest bid wins the work. If none beats a reserve price that is known only to the auctioneer, the procedure is repeated until a bid beats the reserve.
To track competition, the authors honed in on auctions where the two best bids were very close but failed to beat the reserve price. These auctions were run again. Such close bids in the first round—suggesting firms had similar costs or appetite for the job—should mean both bidders had a good chance of winning at the second attempt. Instead, in the second and third rounds of auctions, the order of bids was exactly the same. This suggested a “bidding ring”, a type of cartel in which builders had predetermined who should win. Messrs Kawai and Nakabayashi identify 1,000 firms whose bids were suggestive of collusion. Those firms won 7,600 projects worth almost $8.6 billion.
Slicker sell-offs
Tweaking the rules can make collusion harder, as a study in 2008 by Patrick Bajari and Jungwon Yeo of the University of Minnesota shows. Since 1994 America’s Federal Communications Commission (FCC) has run auctions to sell the spectrum used to transmit television, telephone and radio waves. To foster competition, it banned firms from discussing tactics. In response firms adopted a strategy called “code bidding”, using bids to signal their intentions. A bid of “$1,000,451” could mean, “I intend to go for licence 451. Don’t compete with me.” Other tactics used to deter competitors include “jump” bidding (raising prices by a big step rather than a small one) and “self bumping” (beating your own winning bid with a higher bid, as a display of strength).
Over time tinkering by the FCC has helped. The general rule is to restrict the information bidders have about their rivals. Restricting bidders to a small set of options (allowing bids to be raised by 1%, 5% or 10% per round, for example) prevents code bidding. Anonymous bidding creates a vacuum, breeding suspicion among cartel members. With these changes in place, pricing at FCC auctions has improved. In the 1995 auction of broadband spectrum over 6% of bids were suspicious; by 2008 less than 1% of bids were fishy. Auctions will never be perfect, but with the right rules they may be the best way for governments that are privatising assets to get closest to the best price.