Contract Enforcement and Productive Efficiency: Evidence from the Bidding and Renegotiation of Power Contracts in India

Nicholas Ryan

No 25547, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: Weak contract enforcement may reduce the efficiency of investment in developing countries. I study how contract enforcement affects efficiency in procurement auctions for the largest power projects in India. I gather data on bidding and ex post contract renegotiation and find that the renegotiation of contracts in response to cost shocks is widespread, despite that bidders are allowed to index their bids to future costs like the price of coal. Connected firms choose to index less of the value of their bids to coal prices and, through this strategy, expose themselves to cost shocks to induce renegotiation. I use a structural model of bidding in a scoring auction to characterize equilibrium bidding when bidders are heterogeneous both in cost and in the payments they expect after renegotiation. The model estimates show that bidders offer power below cost due to the expected value of later renegotiation. The model is used to simulate bidding and efficiency with strict contract enforcement. Contract enforcement is found to be pro-competitive. With no renegotiation, equilibrium bids would rise to cover cost, but markups relative to total contract value fall sharply. Production costs decline, due to projects being allocated to lower-cost bidders over those who expect larger payments in renegotiation.

JEL-codes: D44 K12 L94 O14 Q41 (search for similar items in EconPapers)
Date: 2019-02
New Economics Papers: this item is included in nep-law, nep-ppm and nep-reg
Note: DEV EEE IO
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