Econometrica: Mar 2020, Volume 88, Issue 2

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

https://doi.org/10.3982/ECTA17041
p. 383-424

Nicholas Ryan

Weak contract enforcement may reduce the efficiency of production 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. To study heterogeneity in bidding strategies, I construct a new measure of firm connectedness, based on whether a firm has been awarded coal concessions by the Government. 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.



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

This Online Appendix 1 gives additional results to supplement the findings in the main text. This appendix includes summary statistics on the bidding data; an alternative, hazard model for the response of renegotiation to cost shocks; the estimated parameters of the score distribution; alternative specifications of the bidding strategy regressions without controls for bid price; and checks for the robustness of the counterfactual results to different values of the calibrated parameters in the model.

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

This zip file contains the replication files for the manuscript.

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