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Hiccups in US spectrum auctions
Telecommunications Policy 25 (2001) 689–701
Hiccups in US spectrum auctions Mark Scanlan Wissenschaftliches Institut fur . Kommunikationsdienste GmbH (WIK) Bad Honnef, Germany and Economic Research & Consulting Services Ltd (ERCS), England, UK
Abstract While an increasing number of countries have embraced auctions to assign radio frequency, many other countries have decided to retain selection by the administration. Of the many factors that might have influenced those countries that have rejected auctions, one of the most visible in Europe has been frequent media reports of the problems experienced with auctions in the US between 1995 and 1997. In my experience, these reports have been accepted at face value by many European industry commentators and policy officials. It seems clear that the repeated reporting of these problems has influenced the evolution of spectrum management policy in Europe. This paper tries to set the record straight by providing an analysis of the problems that were reported in Europe regarding US spectrum auctions, specifically the declarations of bankruptcy by several winning bidders and overbidding by participants, the enormous revenue shortfall on the WCS block auction, and reports of collusion among bidders. r 2001 Elsevier Science Ltd. All rights reserved.
1. Background While an increasing number of countries have embraced auctions to assign licenses to use radio frequency, many other countries have decided to retain selection by the administration1 such as has occurred recently for the assignment of 3rd generation (3G) mobile licenses.2 Of the many factors that might have influenced those countries that have rejected auctions, one of the most visible has been frequent media reports of the problems experienced by the first countries to auction frequency. Until quite recently, the problems most commonly cited were those
E-mail address: [email protected] (M. Scanlan). This description includes tendering, sometimes referred to by economists as ‘‘beauty contests’’ due to the nontransparent process by which a winner is decided. 2 In the European Union, countries that have chosen to retain administrative decision making for spectrum assignment include France, Spain, Portugal, Sweden, Finland, Luxembourg, and Ireland. 1
0308-5961/01/$ - see front matter r 2001 Elsevier Science Ltd. All rights reserved. PII: S 0 3 0 8 - 5 9 6 1 ( 0 1 ) 0 0 0 3 9 - 8
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experienced in the US between 1995 and 1997.3 In my experience, these media reports tended to be accepted at face value by many European industry commentators and policy officials. It seems clear that the repeated reporting of these problems has influenced the evolution of spectrum management policy in Europe.4 A close examination of the problems experienced in the US in the middle of the 1990s, however, shows that they were relatively minor glitches to a very successful program of spectrum assignment. But because these problems are still referred to today, it suggests that in the intervening years economists have not contributed sufficiently to this debate in order to close the gap between myth and reality. The present paper seeks to address this problem.5
2. Introduction As in many parts of the world, the US has a fairly chequered history when it comes to spectrum management. Prior to 1982, licenses to use the radio spectrum were assigned on a first-come firstserved basis, or by way of comparative hearing whenever there was more than one firm seeking the license. By 1981, the increasing demand for spectrum and the impossible work load required of 3
New Zealand used auctions to assign spectrum 4 years before the US, and in the first of these the auction design seems likely to have lead to an efficient assignment of licenses, but under the particular circumstances that prevailed, the second price auction design chosen embarrassingly resulted in poor revenue performance (in part because bidders’ values were not ‘common’), and generated the information which proved it. 4 In the period leading up to 3G licensing in the EU, a great deal of opposition was expressed to the use of auctions. Replies to Commission consultation documents provide a European sounding-board for interested parties, including consumer groups, and the European telecommunications industry, the latter being generally opposed to auctions. Its views were summarised in the Communication from the Commission on the outcome of the public consultation on UMTS, ‘‘Little support was expressed for market mechanisms, in particular, auctions, since these tend to overprice spectrum, create uncertainty and undermine the development of a healthy industry’’ (COM(97) 513. p. 12–13). Similarly, responses to the Commission’s 1998 Green Paper on Convergence were all but unanimous in their opposition to auctions. The Commission document summarising those comments states, ‘‘There were widespread concerns about the possible auctioning of spectrum, accompanied by assertions that this would raise market entry barriers and lead to increased prices for consumers.’’ In a report by the European Telecommunications Office (ETO) (1998) (which gets financial support from the Commission), the use of auctions was discouraged, the ETO preferred instead comparative hearings i.e. beauty contests. On page 39 it stated, ‘‘In the US, there were bad experiences with auctioning frequencies without screening the candidates on their financial, technical and commercial qualifications. Winners of auctions were unable to make the necessary investments because the licensing fee took up the largest part of their budget or they did not have the necessary experience to build out a successful commercial service.’’ The European Parliament Social and Economic Affairs Committee rapporteur for the Commission’s Green Paper on Convergence said of auctions, ‘‘In particular, auctioning of frequencies creates an imbalance between operators, favouring the most financially powerful and raising the entry cost on the market. Your rapporteur considers that it is therefore to be strongly opposed.’’ An editorial in ‘Broadband’, an internal and informal European Commission magazine, stated, ‘‘The American government’s brainless scheme to auction mobile phone licenses having come unstuck even faster than anticipated, the FCC has been dumped with the task of trying to cook up some sort of acceptable financial deal with the operators who are defaulting on their payments. The nation meanwhile is left with a patchwork of incompatible systems run by a disparate gang of operators, many of whom are teetering on the edge of bankruptcy’’. 5 Our knowledge of auctions was largely developed through academic research over a 10 years period from the late 1970s to the late 1980s. The theory of auctions and bidding processes is a mix of game theory and microeconomics. For an introduction to the theory of auctions, see Rasmusen (1994), Chapter 12; and McAfee and McMillan (1987).
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the FCC to conduct drawn-out quasi-judicial comparative hearings in an effort to minimise the arbitrary nature of this type of decision-making (this is why such processes are also referred to as ‘beauty contests’), prompted Congress to agree to allow licenses to be handed out by lottery. Under the lottery system, applicants were initially screened, but this also proved hugely time consuming for the FCC and in any event it was only partially effective as applicants tended to present themselves as they knew they had to in order to pass pre-screening. In 1987 the prescreening was also abandoned. The licenses were clearly hugely valuable as thousands of firms began filling in ‘short form’ applications and enrolling for the lotteries.6 Secondary markets sprang up so that lottery winners could take their windfall gains. Indeed, the Department of Commerce estimated that the licenses given away in the 1980s boosted the aggregate share values of the companies lucky enough to receive them by $46 Billion.7 In 1993, Congress authorised the FCC to use competitive bidding to assign spectrum licenses. Although there was considerable scepticism among politicians and by those working in the industry about using auctions to assign spectrum in the US, that opposition largely disappeared following the apparent success of the first US auction in 1994. Subsequently, however, US spectrum auctions have not been problem free. There have been reports of collusion among bidders, and that the revenue received from one large block of spectrum was only a tiny fraction of what was expected. This paper tries to set the record straight by providing an analysis of the problems that were reported by the media regarding US spectrum auctions, specifically the declarations of bankruptcy by several winning bidders (Section 3) and overbidding by participants (Section 4), the enormous revenue shortfall on the WCS block auction (Section 5), and reports of collusion among bidders (Section 6). The conclusion is reserved for Section 7.
3. Defaulting bidders In the first two broadband PCS auctions (the A and B block auctions) there were no defaults. A and B block bidders were mainly very large companies, often advised by economists, several of whom had been involved in the major developments of auction theory which mainly occurred over a 10 years period starting from the late 1970s. The bidding activity of each competitor at the auction was ultimately limited by the size of its up-front payment, as determined by the formulaF2 cents per megahertz times the maximum population covered by the licenses the bidder was active on. Up-front payments were returned shortly after the completion of the auction, except for those bidders winning licenses, in which case the up-front payment formed part of the down-payment of 20 percent of the price bid which had to be paid within 5 business days of the close of the auction. The remainder was payable on delivery of the license, usually within 1–3 months after the auction.
6 7
See FCC Report to Congress (1997a–c). McMillan (1995).
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For the C block auction these rules were changed.8 The FCC introduced a scheme where winning bidders were able to pay in instalments over a 10 years period, with the first 6 years involving interest only payments at very favourable rates. In addition, the size of the initial upfront payment was reduced for the C block auction, and more importantly the down-payment required 5 business days after the completion of the auction, was reduced to 5 percent of the price bid.9 The decision to alter the up-front and down-payment formulas, and the length of the payment window, was taken as a result of political pressure rather than the imperative of auction design and good banking practice. The political concern was that the C block auction should enable small businesses (revenues of less than $40 million p.a.) to participate and win licenses.10 One of the purposes behind the design of such auctions and associated payment rules is to limit the chance of bids being anything other than genuine commitments to pay. To this end, the intention of rules governing payment default should be twofold: (i) to prevent the seller from bearing the risk associated with market (information) corrections which can occur between auction completion and final payment,11 and (ii) the rules governing who has the property right in the licenses must be clear at all times. We shall discuss these in turn. 3.1. The payment rules turned the auction into a license competition for options in licenses If the seller does not want to hold the down-side risk of a market correction which can occur between auction completion and final payment, down-payments need to be large enough to fully compensate the seller for any subsequent shortfall in resale license revenues compared with the amount bid by the original winner, should that bidder default. Private investors are best place to assess these risks, and are thus best placed to bare them. They also stand to make any gains due to revaluation of the rights they have acquired, and should rightly bare the cost of any post-auction devaluation in those rights. For this reason, full payment by winning bidders at auction completion has much to recommend it. If the rules back away from this then the payments required at auction completion need to be set at a large enough percentage of each winning bid such that the probability is very 8 The broadband C block auction involved 493 licenses auctioned over 184 rounds lasting 5 months, from December 1995 to May 1996. There were 255 qualified bidders. The sum of the winning bids came to $10.1 billion. 9 Instalment financing was also available in 5 other auctions. Favourable interest rates were offered to C and F block bidders. 10 The Congressional Budget Office report of April 1997 states that 53 percent of auctioned licenses have gone to small businesses. See p. 20. In the first narrow-band PCS auction, small businesses received a 25 percent discount off the amounts they bid, but as none succeeded in winning licenses with this discount, it was raised to 40 percent for the next auction. Bidding credits were also provided to designated bidders in a number of other auctions. Providing discount credits to selective bidders (presumably based on equity or other social considerations) has two distinct advantages over other forms of favouritism: (i) the approximate size of the subsidy made by the state, usually to private investors, is made transparent, e.g. 40 percent off the winning bid (which will be approximately the amount the second highest bidder was prepared to pay) and (ii) when bidders are asymmetric, such as when they plan very different uses for the spectrum they wish to have assigned to them, bid discounting can enable greater bidding pressure to be put on the bidder that values the spectrum most highly, and in this way raise the eventual revenue earned by the seller. McAfee and McMillan (1996), discuss how discounting may have had this effect in the US spectrum auctions. 11 The rules for bid withdrawal were that any shortfall in the final sale price compared with the withdrawn bid would be forfeited.
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low of a market correction at least as large as this percentage. Since changes in the value of financial assets are statistically distributed, the probability of a very large market correction will increase with the length of the observation period, i.e. between auction completion and the date full payment is due. An increase in this time will therefore require an increase in the percentage down-payment if the probability of default is to remain the same.12 Higher default penalties also serve to focus the minds of participants, and require them to have obtained any finance they need prior to bidding. While the down-payment rules identified the total certain amount that could be lost due to default, there were additional assets held by bidders which would also have been under threat if default occurred. This meant that the default option will have been more valuable to those with less to loose, and it will have enabled them to bid higher relative to those with more assets at risk. Thus, the changes in down payment related rules, which need to be considered as part of the broader auction design, tilted the auction in favour of those with fewer assets at risk, thus increased the risk of default from the outset. The actual situation was further complicated by differing levels of risk aversion among bidders, and the different business plans of competitors would have also carried different risks, making the auction a partially rather than fully separating mechanism, favouring those with lower levels of risk aversion, a riskier business plan, and those with fewer assets at stake. This runs counter to what is arguably the central point of the auction; to assign licenses to the highest value bidders, (by which it is meant, firms that will generate more trade (surplus) than the other bidders,13,14 rather than high risk bidders). In the event, the up-front payment for the C block auction was reduced, only a 5 percent down-payment was required within 5 business days of auction completion, only 5 percent was payable on delivery, and the window within which other than very low interest payments were required was increased enormously, such that there was now much more likelihood that the ‘unexpected’ would actually occur. Firms felt they were able to take part in the auction without necessarily having raised the required finance, and if subsequent events occurred which resulted in a substantial devaluation of the auctioned licenses, then finance was not likely to be forthcoming. Especially for those bidders with relatively few other assets at stake, the
12
Without knowing the statistical properties of the financial process(es) which drive market information, it is not possible to provide an accurate linking adjustment between the size of the down-payment and the length of the final payment window. 13 Contribution to GDP is not always the appropriate welfare measure when bidders are distinctly asymmetric, as can occur where allocation and assignment processes are merged. Take the example of a public TV broadcaster having to compete for spectrum at auction with a mobile telecoms operator. Their abilities to bid depend on their expected future profits. The broadcaster generates these by selling TV time to advertisers, as well as from license fees. As a ratio of the surplus remaining for consumers of FTA (free to air) TV, this may be very small. A mobile operator generates profits differently, through subscriber and call charges, and is potentially able to generate profits which leave a smaller proportion of the total surplus to consumers. Taking consumer and producer surplus together, the FTA TV broadcaster may contribute most to the national welfare, but his inability to reflect that in the profits earned can result in the mobile operator outbidding him in a spectrum auction. 14 The C block auction was reserved for small businesses, such that the authorities must have been prepared to provide the licenses to possibly lower value users for equity/political reasons.
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auction started to take on the appearance of a competition for options to buy licenses in the future. The value of this option net of the deposit will predictably result in higher prices being paid for the ‘license options’, a rational response to the offer being made. This point is discussed further in Section 4. As it turned out, the informational developments which occurred after the C block auction resulted in a substantial downward correction in the value investors placed on the C block licenses. Stock prices of companies expected to win C block licenses were very buoyant at the time of the auction. Omnipoint and Intercell were more or less floated at the time of the auction, and their stock price rose dramatically. John Bensche, writing for CS First Boston and subsequently for Lehman Brothers, suggested that those bidding seemed to take their queue from what stock buyers appeared to be saying about the value of C block licenses rather than their own knowledge of the business case. The stock prices seem to have risen on a speculative bubble, and soon after the first C block auction was completed, prices fell substantially resulting in the NPV (net present value) of several winning bidder’s debts being greater than their asset values. The depreciation in the expected value of the licenses/ spectrum naturally resulted in a number of the winning bidders being unable to raise the finances to make their first instalment paymentsFfor some, the least cost solution was to take the default option.15 If this had been the end of the C block saga, damage would have been limited to transaction and administrative costs associated with the metropolitan trading area (MTA) auctions and reauctions of the defaulted licenses, and the added delay in investment, jobs, and the provision of services using the associated spectrum. The seller (taxpayers) would have been out of pocket to the extent that the defaulted amounts would not have been compensated for by the lower selling prices of the re-auctioned licenses. However, as the response of competition among rational bidders to the instalment payments rules was to inflate the prices bid, it is arguable whether the winning bids constituted the proper values by which to assess the treasury’s loss. 3.2. Disputes over property rights More fundamentally, however, the rules governing the property rights in the licenses must enable the seller to fully repossess any license(s) from a defaulting bidder. With the post-auction market correction in the value of C block licenses, some of the firms which won licenses decided that it would be in their best interest to declare bankruptcy. This was an eventuality that the FCC in its newly acquired C block banking functions had not properly prepared for, with the result that the property rights in the licenses passed to the courts under US bankruptcy law. While the rights to these licenses were being disputed in the courts networks were not being built and services were not being provided to consumers, where estimates suggest that investments are approximately twice the amount bid at auction it is apparent that this is where the main fault existed in the C block auction.
15
Of the 4368 licenses auctioned by 30 September 1997, 3.3 percent were not assigned due to non-payment of instalment or down payments.
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Had it not been for the fact that down-payments required from bidders had been kept especially low and instalment payment schemes introduced, the optional aspect of the auction would not have been present, bidders would have been forced to go to the capital markets,16 bid prices would have been lower, and defaults less likely. But most importantly, if the rules had been such as to enable the property right in the licenses to pass back to the seller immediately following default, then if any bidder subsequently discovered that the business case that had originally governed her willingness to pay for licenses was overly optimistic, the ‘problem’ would have remained a largely private one (the winning bidder’s expected profitability on the project would have been reduced) rather than the public problem that it became. Following initial defaults the FCC decided to offer a range of options to C block winners: (i) AmnestyFfirms could return all of their licenses, loose their deposit, but be forgiven their outstanding C block debt, and the licences would be re-auctioned. The defaulting firm would not be precluded from bidding in the auction; (ii) Pre-paymentFfirms could pre-pay the outstanding debt on the licences they wished to retain on a major trading area (MTA) basis and be forgiven the debt and any payments owed on returned licenses, but each would be prohibited from bidding in a re-auction of those licenses; (iii) spectrum disaggregationFauction winners could return half of the spectrum (15 of the 30 MHz) for all of the licenses won in any MTA, and be forgiven half of the debt on those licenses. Firms were also free to continue paying under the original instalment plan.17
4. Overbidding by participants 4.1. Winner’s curse and agency problems The winner’s curse arises in common value auctions where bidders are naive, they have less than perfect information, and there is uncertainty.18 In this case, bids will be statistically distributed, and the winning (naive) bidder will have been the one who made the largest positive error in his estimate of the value of the spectrum. Sophisticated bidders understand this and discount their bids to avoid this outcome. While those businesses taking part in the auctions and individuals bidding on their behalf, may have had little inexperience with auctions in the past, many of the firms bidding in the A and B block auctions acquired the services of economists to advise them. This was less so for the C block
16
To at least partially counter capital market imperfections experienced by small businesses, Federally sponsored low cost finance could still be provided, but it is hard to imagine how unsecured funds could be applied to post-auction upfront payments without introducing an optional element into the auction. Rather, unsecured federally sponsored finance would need to apply exclusively to instalment financing. 17 The modified rules are detailed and complex, as among other things they had to retain the integrity of the original C block auction. For a more detailed analysis and description of the options on offer, see FCC (1998), ‘‘Order on Reconsideration of the Second Report and Order’’ March 1998. 18 Where bidders’ valuations are independent and not related to other bidders’ valuations (i.e. they are completely idiosyncratic or unaffiliated {known as a pure private values auction}), the winner’s curse effect cannot occur. See Milgrom and Weber (1982).
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auction. However, the FCC held pre-auction seminars for bidders, provided bidder information packs, and sent information messages ‘electronically’ over the computerised ‘Automated Auction System’, intended amongst other things to counter the possibility that the winners curse may play a significant part in the auction. Open auctions of the type used by the FCC also have the advantage of making information about each bidder’s private valuations public, further reducing the likelihood that bids would be significantly effected by the winner’s curse.19 Agency problems arise where people are performing functions on behalf of others. Public officials are performing functions on behalf of taxpayers. We are the agents and taxpayers are the Principals’. Company managers (such as bidders at a spectrum auction) are agents for company shareholders. In most cases, agents will have an agenda which does not mirror the agenda of Principals’, and, informational problems will, to a degree, allow agents to pursue their own agendas, which most will inevitably do. In a spectrum auction, agency problems can result in over, and possibly (but it seems very unlikely), underbidding, made possible by the informational problems experienced by the principals. In the C block auctions, a number of those competing were start-up companies where the agents bidding would have been out of a job had no licenses been won. This may have resulted in them bidding rather more than they would have if they had a job to return to had they not won any licenses. The presence of either ‘winners curse’ or private agendas of bidding agents will have resulted in overbidding, and indeed the European media reported overbidding as a problem with the US auctions. An initial comparison of the observation of the dollars bid per person coverage shows that the C block bids were often 60 percent and more higher than similar figures calculated from the A and B block PCS auctions. However, Cramton (1996) argues that whether or not the C block prices were too high, the A and B block prices were too low. He identifies a number of factors. There were only 30 participants and 18 winners in the A and B block auctions, with some of the largest being ineligible to bid in some areas due to competition concerns in the final market.20 This compared with 255 C block bidders with 89 of them winning licenses. The eligibility ratio for A and B block auctions was 1.93 compared with 6.75 for the C block. He notes that in many cases, the A and B block assignments appeared to have been resolved between some competitors without pushing up prices as a means of driving away bidders with a lower willingness. Bidding on A and B blocks was notably very cautious with bidding activity at or near minimum levels, and very little ‘jump bidding’ occurred. Section 6 discusses some of the ‘to pay’ methods used by participants to decide license assignments. For the C block auction, the credit provided to winning firms was at the US Treasury bill interest rate, which is substantially lower than that the market cost of capital for a winning firm. This amounted to a bidding credit of over 30 percent. Combined with the value of the option to default (which varies over time and in accordance with instalment payments made), Cramton (1996) argues that about two-thirds of the spread between the C, and A and B block prices, is 19
Where risk aversion among bidders is significant, theory suggests that bids will be higher under a sealed-bid than open auction. In the judgement of the FCC and its consultant economists, the increased revenue earned by the seller as a result of (involuntary) information sharing under an open auction, was likely to be higher than any reduction in bid sizes under an open auction due to bidder risk aversion. See McMillan (1994). 20 In some cases, the revenue performance of auctions can be seriously impaired by the exclusion of a single bidder. See Bulow and Klemperer (1996).
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explained by the bidding credit and option value contained in the payment rules. Much of the remaining difference seems likely to be explained by the more intensive level of competition for C block licenses. Whether in actuality winner’s curse effects or the private agendas of bidding agents, also played a part in C block defaults, it may not be possible to discover. In any event, the value of the default option and the lack of financial market discipline, appears to have resulted in bids for C block licenses which were so high that some level of defaulting seemed likely. 5. Depressed values due to rushed sales The value of the WCS block had been estimated to be in the order of $1 billion. In the event, however, only $13 million was raised at auction, a fact which was widely publicised in Europe. This outcome has a relatively straightforward explanation. Congress had required by legislation that the WCS block be auctioned beginning from 14 April to enable the sale funds to be deposited at the Treasury before the end of the financial period. This provided the FCC with insufficient time in which to work out technical and interface problems, and allowed potential bidders insufficient time to prepare business plans and raise finance.21 Very tight interference limits with digital audio radio were not set until shortly before the auction. The same factors greatly increased bidders’ risk and therefore lowered the amounts they were prepared to bid for the WCS block. They will likely also have kept down the numbers of participants in the auction, and some of those who did participate may have been prevented from even bidding up to the levels they would have been prepared to pay due to financial constraints. If the organisations which made early predictions of the value of the WCS licenses had been in possession of this information they would at the very least have recorded much lower expected license values, and because of the great uncertainty involved, may have refrained from publishing estimates at all. Following the auction, the winners formed a group to work out remaining technical and interface problems. 6. Collusion during auctions Of the 17 spectrum auctions conducted by the FCC up to July 1998, 13 were simultaneous multi-round (SMR) auctions. Compared to sealed bid auctions, SMR auctions tend to be more open to collusion as they enable breaches of (possibly tacit) agreements reached either prior to or during an auction, to be punished by some sort of retaliatory strategy by the other party(s) to the agreement, thus enabling colluding bidders to better maintain their agreement through the completion of the auction.22 We can group the attempts to collude in the US spectrum auctions into two types: (i) ‘code bidding’ and (ii) strategic bid placement or bid withdrawal. A problem experienced mainly with the PCS DEF block auction was that some bidders appeared to have used the trailing digits on their bids to signal information to other bidders 21
Low biding was predicted in a letter from Bureau chief Farquhar to the Honourable Thomas Bliley dated 5 February 1997. 22 SMR auction design enable bidders’ to seek to combine areas where they consider the complimentarities warrant it.
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during the auction. Cramton and Schwartz (1998) provide an example. ‘‘Mercury PCS ended its bids with market numbers to signal its rival, High Plains Wireless, that it wanted it to move off of Lubbock, Texas, or that it would be punished on Amarillo, Texas. Each market has a three digit market number (264 for Lubbock and 013 for Amarillo). After trading bids on block F of Lubbock for several rounds, with the price rising by 10 percent in each round, Mercury bumped High Plains in round 121 from Amarillo, a market on which High Plains had been the standing high bidder since round 68. This was Mercury’s first bid on Amarillo during the auction. The bid served as a punishment for High Plains bidding against Mercury on Lubbock, a punishment made clear since the bid amount contained as its last three digits ‘264’, the market number for Lubbock. Mercury’s bid on Amarillo said to High Plains, ‘I am bumping you from Amarillo, a market you have held since round 68, a market I have shown no interest in whatsoever. y I want you to back off of Lubbock, leave it to me.’ To clarify that the Amarillo bid was a retaliation for High Plains bid on Lubbock, Mercury tagged its rebid in Lubbock with ‘013’y. This strategy worked and High Plains backed off of Lubbock.’’23 The FCC fined Mercury $650,000 for making 13 codebids.24 While code-bidding makes communication with rivals easier, it is not essential for bidders to successfully signal to rivals in order to reduce the amount of bidding on specific licenses. Strategic bid placement and/or bid withdrawal can convey similar information. It is quite possible, for example, that White Plains would have understood the message from Mercury even without the three digit codes being attached to Mercury’s bids. Concerning the A and B block auctions, Cramton (1996, p. 21) writes, ‘‘one pair of withdrawals was apparently intended as a gift to entice a competitor to shift to the withdrawn licenses. In round 97, WirelessCo withdraw from Tampa and Houston, hoping that American Portable would take this gift and move off San Francisco. American Portable accepted the gift, moving down to Tampa and Houston in the next round. WirelessCo’s gift cost it $8.505 million in withdrawal penalties, but this was less than one bid increment in San Francisco.’’ What bidders were attempting was to reach an understanding with rivals as to which of them would get specific licenses without having to decide this through pushing the auction price too high.25 However, where tacit collusion does not result in disagreement among the parties during the auction, code and/or strategic bidding need not have appeared. In an effort to uncover whether ‘silent’ collusion may also have been important in the FCC auctions, Cramton and Schwartz used econometric techniques to discover that those guilty of bid signalling were as a whole successful in winning licenses at unusually low prices.26 Our ability to put a cost on collusion is severally limited, however, due to our inability to witness every instance. But it seems fair to say that for the DEF block auction, it was far greater than the $6 million to $14 million cost attributable to code-bidding alone (see footnote 25). The FCC has stated that its primary motivation for using auctions has not been their ability to generate revenue, but rather their ability to assign licenses to those firms which value them the 23
Cramton and Schwartz (1998, p. 7). The licenses in Lubbock sold for a little over $2 million. 25 In the DEF block auction, it has been estimated that the FCC lost between $6 million and $14 million due to code bidding and strategic retaliation. See Cramton and Schwartz (1998). 26 Reported in Cramton and Schwartz (1998). 24
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most. Where an auction is effected by collusion, however, those winning specific licenses or combinations of licenses need not be the firms which value those licenses the most. From auction 16 (which ended in December 1997) onward, the FCC has made several amendments to its auction rules which it considers should substantially reduce the risk of collusion in future auctions.27
7. Conclusion It seems highly unlikely that the FCC’s economic advisors or the FCC economists involved in the design of the auctions would not have been aware that problems might arise if: *
*
the auction payment rules were adjusted giving bidders, among other things, a lengthy window in which to exercise the default option, or the sale of the licenses in one block of spectrum was rushing through before technical and regulatory/legal rules could be finalised.
As for the C block licenses which fell under the control of the courts and US bankruptcy law, it seems that this was a genuine oversight on the part of the FCC, an organisation that has subsequently admitted, it has no great expertise in banking matters. If the auction designers had not been under political pressure to alter certain aspects of the auction and payment rules, the problems involving the C block auction (e.g. ‘excessive’ defaulting) or the poor revenue performance of the WCS auction, would not have occurred. The same cannot be said about the incidence of collusion among bidders. Some level of tacit collusion was present in a number of auctions, but in none of them does it appear that the overall efficacy of the auction was undermined. Further, amendments to the rules for future auctions have made collusion more difficult. But for those who think that by not using auctions to assign licenses they are avoiding collusion, think again. The incentive for rivals to collude in ‘competitions’, where the winners of extremely valuable rights to assets are being decided, is powerful, and it is perhaps only the personal morality of individual agents, or the threat of being caught, that prevents collusion in any particular case. In more traditional sealed bid tenders, there appears to be ample evidence that collusion has been widespread in the US and Europe, particularly for government or municipal licenses or contracts.28 Moreover, where refinements to SMR auction design make tacit collusion difficult to enforce during the auction, it seems likely that rivals may look again at methods of express collusion, much as can and does occur with sealed bid tenders. 7.1. So what lessons can the rest of the World learn from the US experience? The main message is that taken as a whole, spectrum auctions in the US have been a great success. As at 25 March 1998, which is about the end of the reportedly problematic licensing period, 5893 licenses had been auctioned with winning bids totalling $23 billion. (As of February 27 Although the level of communication with code-bidding seems direct enough for it to be a violation of general competition law, many attempts to collude could not be successfully prosecuted under competition law. For example, cases of strategic bid withdrawal, such as by WirelessCo, are unlikely to result in the courts finding a competition law violation. 28 See McAfee and McMillan (1992, pp. 579–599).
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2001 this amount had reached $41 billion). Defaulting has in fact been minimal, and in any event instalment payment schemes are no longer used. Prior to the adoption of auctions as the primary mechanism for spectrum assignment in the US, it had taken on average 720 days to get spectrum assigned under earlier beauty contests and 412 days under the lottery system. Using auctions the FCC has averaged 233 days from the filing of application until the license is actually granted, Moreover, with few exceptions the auctions will have put spectrum in the hands of the highest value users, something which no other assignment method can claim. Finally, the difficulties experienced in the US which were discussed in this paper, suggest that what other countries need to avoid is not auctions, but political interference which ties the hands of the auction designers. 7.1.1. Postscript Since this paper was drafted, there has been a downturn in the economic outlook for most businesses, including telecommunications companies. In the EU, several of the operators that have acquired 3G licenses now find their debt to market value to be uncomfortably high, and have been lobbying EU and individual country officials and politicians in an effort to get some relief. Judging by media reports, the main point lobbyists appear to have made is that the 3G auctions ‘held up’ operators for ransom, and the resulting debts will substantially delay the rollout of 3G infrastructure and thereby put back the economic development of the EU.29 The present time seems opportune for policy economists to critique these arguments, much as this paper has done in regard to events that took place in the auctioning of PCS licenses in the US Acknowledgements The author wishes to thank Evan Kwerel (FCC) and John McMillan (Stanford University) for information and advice they gave him in 1997/1998 relating to the issues discussed in this paper. He also wishes to thank Lorenz Nett of WIK for more recent comments. Incidentally, WIK was responsible for the policy advice, auction design and operating systems used for the 3G auction in Germany. The usual disclaimer applies.
References Bulow, J., & Klemperer, P. (1996). Auctions Versus Negotiations. American Economic Review, 86(1), 180–194. Congressional Budget Office Report (1997). Where Do We Go From Here? The FCC Auctions and the Future of Radio Spectrum Management. Cramton, P. (1996). The FCC spectrum auctions: An early assessment, Mimeo, University of Maryland.
29
Recent examples of reports in the press can be found in the following: For examples of reports about excessive license fees see Europe Asks, 3G or not 3G? by Matt Hilburn, 30 January 2001, http://www.wired.com/news/technology/ 0,1282,41481,00.html, and the letter to the editor in reply to this issue by Ken Binmore (University College, London) one of the economists who assisted in designing the UK’s 3G auction ( http://www.guardianunlimited.co.uk/letters/ story/0,3604,434417,00.html). Overbidding for 3G licenses in Europe was reported by Dan Milmo, Media Guardian, 29 January 2001 (See, http://www.mediaguardian.co.uk/city/story/0,7497,430344,00.html).
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Cramton, P., & Schwartz, J. (1998). Collusive bidding: Lessons from the FCC spectrum auctions, Mimeo, University of Maryland. European Telecommunications Office (ETO) (1998). Licensing Conditions for mobile Communications. FCC (1997a). Report to Congress. WT Docket No. 97-150. FCC (1997b). Third annual CMRS competition report. FCC (1997c). Report to Congress on spectrum auctions, 97-353. FCC (1998). Order on reconsideration of the second report and order, March 23, WT Docket No. 97-82. McAfee, P., & McMillan, J. (1987). Auctions and bidding. Journal of Economic Literature, (XXV), 699–738. McAfee, P., & McMillan, J. (1992a). Bidding rings. American Economic Review, 82(3), 579–599. McAfee, P., & McMillan, J. (1996). Analysing the airwaves auction. Journal of Economic Perspectives, 10(1), 159–175. McMillan, J. (1994). Selling spectrum rights. Journal of Economic Perspectives, 8(3), 145–162. McMillan, J. (1995). Why auction the spectrum? Telecommunications Policy, 191–199. Milgrom, P., & Weber, R. (1982). A theory of auctions and competitive bidding. Econometrica, 50(5), 1089–1122. Rasmusen, E. (1994). Games and information ((2nd ed.)). Cambridge, MA: Blackwell.
Hiccups in US spectrum auctions Mark Scanlan Wissenschaftliches Institut fur . Kommunikationsdienste GmbH (WIK) Bad Honnef, Germany and Economic Research & Consulting Services Ltd (ERCS), England, UK
Abstract While an increasing number of countries have embraced auctions to assign radio frequency, many other countries have decided to retain selection by the administration. Of the many factors that might have influenced those countries that have rejected auctions, one of the most visible in Europe has been frequent media reports of the problems experienced with auctions in the US between 1995 and 1997. In my experience, these reports have been accepted at face value by many European industry commentators and policy officials. It seems clear that the repeated reporting of these problems has influenced the evolution of spectrum management policy in Europe. This paper tries to set the record straight by providing an analysis of the problems that were reported in Europe regarding US spectrum auctions, specifically the declarations of bankruptcy by several winning bidders and overbidding by participants, the enormous revenue shortfall on the WCS block auction, and reports of collusion among bidders. r 2001 Elsevier Science Ltd. All rights reserved.
1. Background While an increasing number of countries have embraced auctions to assign licenses to use radio frequency, many other countries have decided to retain selection by the administration1 such as has occurred recently for the assignment of 3rd generation (3G) mobile licenses.2 Of the many factors that might have influenced those countries that have rejected auctions, one of the most visible has been frequent media reports of the problems experienced by the first countries to auction frequency. Until quite recently, the problems most commonly cited were those
E-mail address: [email protected] (M. Scanlan). This description includes tendering, sometimes referred to by economists as ‘‘beauty contests’’ due to the nontransparent process by which a winner is decided. 2 In the European Union, countries that have chosen to retain administrative decision making for spectrum assignment include France, Spain, Portugal, Sweden, Finland, Luxembourg, and Ireland. 1
0308-5961/01/$ - see front matter r 2001 Elsevier Science Ltd. All rights reserved. PII: S 0 3 0 8 - 5 9 6 1 ( 0 1 ) 0 0 0 3 9 - 8
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experienced in the US between 1995 and 1997.3 In my experience, these media reports tended to be accepted at face value by many European industry commentators and policy officials. It seems clear that the repeated reporting of these problems has influenced the evolution of spectrum management policy in Europe.4 A close examination of the problems experienced in the US in the middle of the 1990s, however, shows that they were relatively minor glitches to a very successful program of spectrum assignment. But because these problems are still referred to today, it suggests that in the intervening years economists have not contributed sufficiently to this debate in order to close the gap between myth and reality. The present paper seeks to address this problem.5
2. Introduction As in many parts of the world, the US has a fairly chequered history when it comes to spectrum management. Prior to 1982, licenses to use the radio spectrum were assigned on a first-come firstserved basis, or by way of comparative hearing whenever there was more than one firm seeking the license. By 1981, the increasing demand for spectrum and the impossible work load required of 3
New Zealand used auctions to assign spectrum 4 years before the US, and in the first of these the auction design seems likely to have lead to an efficient assignment of licenses, but under the particular circumstances that prevailed, the second price auction design chosen embarrassingly resulted in poor revenue performance (in part because bidders’ values were not ‘common’), and generated the information which proved it. 4 In the period leading up to 3G licensing in the EU, a great deal of opposition was expressed to the use of auctions. Replies to Commission consultation documents provide a European sounding-board for interested parties, including consumer groups, and the European telecommunications industry, the latter being generally opposed to auctions. Its views were summarised in the Communication from the Commission on the outcome of the public consultation on UMTS, ‘‘Little support was expressed for market mechanisms, in particular, auctions, since these tend to overprice spectrum, create uncertainty and undermine the development of a healthy industry’’ (COM(97) 513. p. 12–13). Similarly, responses to the Commission’s 1998 Green Paper on Convergence were all but unanimous in their opposition to auctions. The Commission document summarising those comments states, ‘‘There were widespread concerns about the possible auctioning of spectrum, accompanied by assertions that this would raise market entry barriers and lead to increased prices for consumers.’’ In a report by the European Telecommunications Office (ETO) (1998) (which gets financial support from the Commission), the use of auctions was discouraged, the ETO preferred instead comparative hearings i.e. beauty contests. On page 39 it stated, ‘‘In the US, there were bad experiences with auctioning frequencies without screening the candidates on their financial, technical and commercial qualifications. Winners of auctions were unable to make the necessary investments because the licensing fee took up the largest part of their budget or they did not have the necessary experience to build out a successful commercial service.’’ The European Parliament Social and Economic Affairs Committee rapporteur for the Commission’s Green Paper on Convergence said of auctions, ‘‘In particular, auctioning of frequencies creates an imbalance between operators, favouring the most financially powerful and raising the entry cost on the market. Your rapporteur considers that it is therefore to be strongly opposed.’’ An editorial in ‘Broadband’, an internal and informal European Commission magazine, stated, ‘‘The American government’s brainless scheme to auction mobile phone licenses having come unstuck even faster than anticipated, the FCC has been dumped with the task of trying to cook up some sort of acceptable financial deal with the operators who are defaulting on their payments. The nation meanwhile is left with a patchwork of incompatible systems run by a disparate gang of operators, many of whom are teetering on the edge of bankruptcy’’. 5 Our knowledge of auctions was largely developed through academic research over a 10 years period from the late 1970s to the late 1980s. The theory of auctions and bidding processes is a mix of game theory and microeconomics. For an introduction to the theory of auctions, see Rasmusen (1994), Chapter 12; and McAfee and McMillan (1987).
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the FCC to conduct drawn-out quasi-judicial comparative hearings in an effort to minimise the arbitrary nature of this type of decision-making (this is why such processes are also referred to as ‘beauty contests’), prompted Congress to agree to allow licenses to be handed out by lottery. Under the lottery system, applicants were initially screened, but this also proved hugely time consuming for the FCC and in any event it was only partially effective as applicants tended to present themselves as they knew they had to in order to pass pre-screening. In 1987 the prescreening was also abandoned. The licenses were clearly hugely valuable as thousands of firms began filling in ‘short form’ applications and enrolling for the lotteries.6 Secondary markets sprang up so that lottery winners could take their windfall gains. Indeed, the Department of Commerce estimated that the licenses given away in the 1980s boosted the aggregate share values of the companies lucky enough to receive them by $46 Billion.7 In 1993, Congress authorised the FCC to use competitive bidding to assign spectrum licenses. Although there was considerable scepticism among politicians and by those working in the industry about using auctions to assign spectrum in the US, that opposition largely disappeared following the apparent success of the first US auction in 1994. Subsequently, however, US spectrum auctions have not been problem free. There have been reports of collusion among bidders, and that the revenue received from one large block of spectrum was only a tiny fraction of what was expected. This paper tries to set the record straight by providing an analysis of the problems that were reported by the media regarding US spectrum auctions, specifically the declarations of bankruptcy by several winning bidders (Section 3) and overbidding by participants (Section 4), the enormous revenue shortfall on the WCS block auction (Section 5), and reports of collusion among bidders (Section 6). The conclusion is reserved for Section 7.
3. Defaulting bidders In the first two broadband PCS auctions (the A and B block auctions) there were no defaults. A and B block bidders were mainly very large companies, often advised by economists, several of whom had been involved in the major developments of auction theory which mainly occurred over a 10 years period starting from the late 1970s. The bidding activity of each competitor at the auction was ultimately limited by the size of its up-front payment, as determined by the formulaF2 cents per megahertz times the maximum population covered by the licenses the bidder was active on. Up-front payments were returned shortly after the completion of the auction, except for those bidders winning licenses, in which case the up-front payment formed part of the down-payment of 20 percent of the price bid which had to be paid within 5 business days of the close of the auction. The remainder was payable on delivery of the license, usually within 1–3 months after the auction.
6 7
See FCC Report to Congress (1997a–c). McMillan (1995).
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For the C block auction these rules were changed.8 The FCC introduced a scheme where winning bidders were able to pay in instalments over a 10 years period, with the first 6 years involving interest only payments at very favourable rates. In addition, the size of the initial upfront payment was reduced for the C block auction, and more importantly the down-payment required 5 business days after the completion of the auction, was reduced to 5 percent of the price bid.9 The decision to alter the up-front and down-payment formulas, and the length of the payment window, was taken as a result of political pressure rather than the imperative of auction design and good banking practice. The political concern was that the C block auction should enable small businesses (revenues of less than $40 million p.a.) to participate and win licenses.10 One of the purposes behind the design of such auctions and associated payment rules is to limit the chance of bids being anything other than genuine commitments to pay. To this end, the intention of rules governing payment default should be twofold: (i) to prevent the seller from bearing the risk associated with market (information) corrections which can occur between auction completion and final payment,11 and (ii) the rules governing who has the property right in the licenses must be clear at all times. We shall discuss these in turn. 3.1. The payment rules turned the auction into a license competition for options in licenses If the seller does not want to hold the down-side risk of a market correction which can occur between auction completion and final payment, down-payments need to be large enough to fully compensate the seller for any subsequent shortfall in resale license revenues compared with the amount bid by the original winner, should that bidder default. Private investors are best place to assess these risks, and are thus best placed to bare them. They also stand to make any gains due to revaluation of the rights they have acquired, and should rightly bare the cost of any post-auction devaluation in those rights. For this reason, full payment by winning bidders at auction completion has much to recommend it. If the rules back away from this then the payments required at auction completion need to be set at a large enough percentage of each winning bid such that the probability is very 8 The broadband C block auction involved 493 licenses auctioned over 184 rounds lasting 5 months, from December 1995 to May 1996. There were 255 qualified bidders. The sum of the winning bids came to $10.1 billion. 9 Instalment financing was also available in 5 other auctions. Favourable interest rates were offered to C and F block bidders. 10 The Congressional Budget Office report of April 1997 states that 53 percent of auctioned licenses have gone to small businesses. See p. 20. In the first narrow-band PCS auction, small businesses received a 25 percent discount off the amounts they bid, but as none succeeded in winning licenses with this discount, it was raised to 40 percent for the next auction. Bidding credits were also provided to designated bidders in a number of other auctions. Providing discount credits to selective bidders (presumably based on equity or other social considerations) has two distinct advantages over other forms of favouritism: (i) the approximate size of the subsidy made by the state, usually to private investors, is made transparent, e.g. 40 percent off the winning bid (which will be approximately the amount the second highest bidder was prepared to pay) and (ii) when bidders are asymmetric, such as when they plan very different uses for the spectrum they wish to have assigned to them, bid discounting can enable greater bidding pressure to be put on the bidder that values the spectrum most highly, and in this way raise the eventual revenue earned by the seller. McAfee and McMillan (1996), discuss how discounting may have had this effect in the US spectrum auctions. 11 The rules for bid withdrawal were that any shortfall in the final sale price compared with the withdrawn bid would be forfeited.
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low of a market correction at least as large as this percentage. Since changes in the value of financial assets are statistically distributed, the probability of a very large market correction will increase with the length of the observation period, i.e. between auction completion and the date full payment is due. An increase in this time will therefore require an increase in the percentage down-payment if the probability of default is to remain the same.12 Higher default penalties also serve to focus the minds of participants, and require them to have obtained any finance they need prior to bidding. While the down-payment rules identified the total certain amount that could be lost due to default, there were additional assets held by bidders which would also have been under threat if default occurred. This meant that the default option will have been more valuable to those with less to loose, and it will have enabled them to bid higher relative to those with more assets at risk. Thus, the changes in down payment related rules, which need to be considered as part of the broader auction design, tilted the auction in favour of those with fewer assets at risk, thus increased the risk of default from the outset. The actual situation was further complicated by differing levels of risk aversion among bidders, and the different business plans of competitors would have also carried different risks, making the auction a partially rather than fully separating mechanism, favouring those with lower levels of risk aversion, a riskier business plan, and those with fewer assets at stake. This runs counter to what is arguably the central point of the auction; to assign licenses to the highest value bidders, (by which it is meant, firms that will generate more trade (surplus) than the other bidders,13,14 rather than high risk bidders). In the event, the up-front payment for the C block auction was reduced, only a 5 percent down-payment was required within 5 business days of auction completion, only 5 percent was payable on delivery, and the window within which other than very low interest payments were required was increased enormously, such that there was now much more likelihood that the ‘unexpected’ would actually occur. Firms felt they were able to take part in the auction without necessarily having raised the required finance, and if subsequent events occurred which resulted in a substantial devaluation of the auctioned licenses, then finance was not likely to be forthcoming. Especially for those bidders with relatively few other assets at stake, the
12
Without knowing the statistical properties of the financial process(es) which drive market information, it is not possible to provide an accurate linking adjustment between the size of the down-payment and the length of the final payment window. 13 Contribution to GDP is not always the appropriate welfare measure when bidders are distinctly asymmetric, as can occur where allocation and assignment processes are merged. Take the example of a public TV broadcaster having to compete for spectrum at auction with a mobile telecoms operator. Their abilities to bid depend on their expected future profits. The broadcaster generates these by selling TV time to advertisers, as well as from license fees. As a ratio of the surplus remaining for consumers of FTA (free to air) TV, this may be very small. A mobile operator generates profits differently, through subscriber and call charges, and is potentially able to generate profits which leave a smaller proportion of the total surplus to consumers. Taking consumer and producer surplus together, the FTA TV broadcaster may contribute most to the national welfare, but his inability to reflect that in the profits earned can result in the mobile operator outbidding him in a spectrum auction. 14 The C block auction was reserved for small businesses, such that the authorities must have been prepared to provide the licenses to possibly lower value users for equity/political reasons.
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auction started to take on the appearance of a competition for options to buy licenses in the future. The value of this option net of the deposit will predictably result in higher prices being paid for the ‘license options’, a rational response to the offer being made. This point is discussed further in Section 4. As it turned out, the informational developments which occurred after the C block auction resulted in a substantial downward correction in the value investors placed on the C block licenses. Stock prices of companies expected to win C block licenses were very buoyant at the time of the auction. Omnipoint and Intercell were more or less floated at the time of the auction, and their stock price rose dramatically. John Bensche, writing for CS First Boston and subsequently for Lehman Brothers, suggested that those bidding seemed to take their queue from what stock buyers appeared to be saying about the value of C block licenses rather than their own knowledge of the business case. The stock prices seem to have risen on a speculative bubble, and soon after the first C block auction was completed, prices fell substantially resulting in the NPV (net present value) of several winning bidder’s debts being greater than their asset values. The depreciation in the expected value of the licenses/ spectrum naturally resulted in a number of the winning bidders being unable to raise the finances to make their first instalment paymentsFfor some, the least cost solution was to take the default option.15 If this had been the end of the C block saga, damage would have been limited to transaction and administrative costs associated with the metropolitan trading area (MTA) auctions and reauctions of the defaulted licenses, and the added delay in investment, jobs, and the provision of services using the associated spectrum. The seller (taxpayers) would have been out of pocket to the extent that the defaulted amounts would not have been compensated for by the lower selling prices of the re-auctioned licenses. However, as the response of competition among rational bidders to the instalment payments rules was to inflate the prices bid, it is arguable whether the winning bids constituted the proper values by which to assess the treasury’s loss. 3.2. Disputes over property rights More fundamentally, however, the rules governing the property rights in the licenses must enable the seller to fully repossess any license(s) from a defaulting bidder. With the post-auction market correction in the value of C block licenses, some of the firms which won licenses decided that it would be in their best interest to declare bankruptcy. This was an eventuality that the FCC in its newly acquired C block banking functions had not properly prepared for, with the result that the property rights in the licenses passed to the courts under US bankruptcy law. While the rights to these licenses were being disputed in the courts networks were not being built and services were not being provided to consumers, where estimates suggest that investments are approximately twice the amount bid at auction it is apparent that this is where the main fault existed in the C block auction.
15
Of the 4368 licenses auctioned by 30 September 1997, 3.3 percent were not assigned due to non-payment of instalment or down payments.
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Had it not been for the fact that down-payments required from bidders had been kept especially low and instalment payment schemes introduced, the optional aspect of the auction would not have been present, bidders would have been forced to go to the capital markets,16 bid prices would have been lower, and defaults less likely. But most importantly, if the rules had been such as to enable the property right in the licenses to pass back to the seller immediately following default, then if any bidder subsequently discovered that the business case that had originally governed her willingness to pay for licenses was overly optimistic, the ‘problem’ would have remained a largely private one (the winning bidder’s expected profitability on the project would have been reduced) rather than the public problem that it became. Following initial defaults the FCC decided to offer a range of options to C block winners: (i) AmnestyFfirms could return all of their licenses, loose their deposit, but be forgiven their outstanding C block debt, and the licences would be re-auctioned. The defaulting firm would not be precluded from bidding in the auction; (ii) Pre-paymentFfirms could pre-pay the outstanding debt on the licences they wished to retain on a major trading area (MTA) basis and be forgiven the debt and any payments owed on returned licenses, but each would be prohibited from bidding in a re-auction of those licenses; (iii) spectrum disaggregationFauction winners could return half of the spectrum (15 of the 30 MHz) for all of the licenses won in any MTA, and be forgiven half of the debt on those licenses. Firms were also free to continue paying under the original instalment plan.17
4. Overbidding by participants 4.1. Winner’s curse and agency problems The winner’s curse arises in common value auctions where bidders are naive, they have less than perfect information, and there is uncertainty.18 In this case, bids will be statistically distributed, and the winning (naive) bidder will have been the one who made the largest positive error in his estimate of the value of the spectrum. Sophisticated bidders understand this and discount their bids to avoid this outcome. While those businesses taking part in the auctions and individuals bidding on their behalf, may have had little inexperience with auctions in the past, many of the firms bidding in the A and B block auctions acquired the services of economists to advise them. This was less so for the C block
16
To at least partially counter capital market imperfections experienced by small businesses, Federally sponsored low cost finance could still be provided, but it is hard to imagine how unsecured funds could be applied to post-auction upfront payments without introducing an optional element into the auction. Rather, unsecured federally sponsored finance would need to apply exclusively to instalment financing. 17 The modified rules are detailed and complex, as among other things they had to retain the integrity of the original C block auction. For a more detailed analysis and description of the options on offer, see FCC (1998), ‘‘Order on Reconsideration of the Second Report and Order’’ March 1998. 18 Where bidders’ valuations are independent and not related to other bidders’ valuations (i.e. they are completely idiosyncratic or unaffiliated {known as a pure private values auction}), the winner’s curse effect cannot occur. See Milgrom and Weber (1982).
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auction. However, the FCC held pre-auction seminars for bidders, provided bidder information packs, and sent information messages ‘electronically’ over the computerised ‘Automated Auction System’, intended amongst other things to counter the possibility that the winners curse may play a significant part in the auction. Open auctions of the type used by the FCC also have the advantage of making information about each bidder’s private valuations public, further reducing the likelihood that bids would be significantly effected by the winner’s curse.19 Agency problems arise where people are performing functions on behalf of others. Public officials are performing functions on behalf of taxpayers. We are the agents and taxpayers are the Principals’. Company managers (such as bidders at a spectrum auction) are agents for company shareholders. In most cases, agents will have an agenda which does not mirror the agenda of Principals’, and, informational problems will, to a degree, allow agents to pursue their own agendas, which most will inevitably do. In a spectrum auction, agency problems can result in over, and possibly (but it seems very unlikely), underbidding, made possible by the informational problems experienced by the principals. In the C block auctions, a number of those competing were start-up companies where the agents bidding would have been out of a job had no licenses been won. This may have resulted in them bidding rather more than they would have if they had a job to return to had they not won any licenses. The presence of either ‘winners curse’ or private agendas of bidding agents will have resulted in overbidding, and indeed the European media reported overbidding as a problem with the US auctions. An initial comparison of the observation of the dollars bid per person coverage shows that the C block bids were often 60 percent and more higher than similar figures calculated from the A and B block PCS auctions. However, Cramton (1996) argues that whether or not the C block prices were too high, the A and B block prices were too low. He identifies a number of factors. There were only 30 participants and 18 winners in the A and B block auctions, with some of the largest being ineligible to bid in some areas due to competition concerns in the final market.20 This compared with 255 C block bidders with 89 of them winning licenses. The eligibility ratio for A and B block auctions was 1.93 compared with 6.75 for the C block. He notes that in many cases, the A and B block assignments appeared to have been resolved between some competitors without pushing up prices as a means of driving away bidders with a lower willingness. Bidding on A and B blocks was notably very cautious with bidding activity at or near minimum levels, and very little ‘jump bidding’ occurred. Section 6 discusses some of the ‘to pay’ methods used by participants to decide license assignments. For the C block auction, the credit provided to winning firms was at the US Treasury bill interest rate, which is substantially lower than that the market cost of capital for a winning firm. This amounted to a bidding credit of over 30 percent. Combined with the value of the option to default (which varies over time and in accordance with instalment payments made), Cramton (1996) argues that about two-thirds of the spread between the C, and A and B block prices, is 19
Where risk aversion among bidders is significant, theory suggests that bids will be higher under a sealed-bid than open auction. In the judgement of the FCC and its consultant economists, the increased revenue earned by the seller as a result of (involuntary) information sharing under an open auction, was likely to be higher than any reduction in bid sizes under an open auction due to bidder risk aversion. See McMillan (1994). 20 In some cases, the revenue performance of auctions can be seriously impaired by the exclusion of a single bidder. See Bulow and Klemperer (1996).
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explained by the bidding credit and option value contained in the payment rules. Much of the remaining difference seems likely to be explained by the more intensive level of competition for C block licenses. Whether in actuality winner’s curse effects or the private agendas of bidding agents, also played a part in C block defaults, it may not be possible to discover. In any event, the value of the default option and the lack of financial market discipline, appears to have resulted in bids for C block licenses which were so high that some level of defaulting seemed likely. 5. Depressed values due to rushed sales The value of the WCS block had been estimated to be in the order of $1 billion. In the event, however, only $13 million was raised at auction, a fact which was widely publicised in Europe. This outcome has a relatively straightforward explanation. Congress had required by legislation that the WCS block be auctioned beginning from 14 April to enable the sale funds to be deposited at the Treasury before the end of the financial period. This provided the FCC with insufficient time in which to work out technical and interface problems, and allowed potential bidders insufficient time to prepare business plans and raise finance.21 Very tight interference limits with digital audio radio were not set until shortly before the auction. The same factors greatly increased bidders’ risk and therefore lowered the amounts they were prepared to bid for the WCS block. They will likely also have kept down the numbers of participants in the auction, and some of those who did participate may have been prevented from even bidding up to the levels they would have been prepared to pay due to financial constraints. If the organisations which made early predictions of the value of the WCS licenses had been in possession of this information they would at the very least have recorded much lower expected license values, and because of the great uncertainty involved, may have refrained from publishing estimates at all. Following the auction, the winners formed a group to work out remaining technical and interface problems. 6. Collusion during auctions Of the 17 spectrum auctions conducted by the FCC up to July 1998, 13 were simultaneous multi-round (SMR) auctions. Compared to sealed bid auctions, SMR auctions tend to be more open to collusion as they enable breaches of (possibly tacit) agreements reached either prior to or during an auction, to be punished by some sort of retaliatory strategy by the other party(s) to the agreement, thus enabling colluding bidders to better maintain their agreement through the completion of the auction.22 We can group the attempts to collude in the US spectrum auctions into two types: (i) ‘code bidding’ and (ii) strategic bid placement or bid withdrawal. A problem experienced mainly with the PCS DEF block auction was that some bidders appeared to have used the trailing digits on their bids to signal information to other bidders 21
Low biding was predicted in a letter from Bureau chief Farquhar to the Honourable Thomas Bliley dated 5 February 1997. 22 SMR auction design enable bidders’ to seek to combine areas where they consider the complimentarities warrant it.
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during the auction. Cramton and Schwartz (1998) provide an example. ‘‘Mercury PCS ended its bids with market numbers to signal its rival, High Plains Wireless, that it wanted it to move off of Lubbock, Texas, or that it would be punished on Amarillo, Texas. Each market has a three digit market number (264 for Lubbock and 013 for Amarillo). After trading bids on block F of Lubbock for several rounds, with the price rising by 10 percent in each round, Mercury bumped High Plains in round 121 from Amarillo, a market on which High Plains had been the standing high bidder since round 68. This was Mercury’s first bid on Amarillo during the auction. The bid served as a punishment for High Plains bidding against Mercury on Lubbock, a punishment made clear since the bid amount contained as its last three digits ‘264’, the market number for Lubbock. Mercury’s bid on Amarillo said to High Plains, ‘I am bumping you from Amarillo, a market you have held since round 68, a market I have shown no interest in whatsoever. y I want you to back off of Lubbock, leave it to me.’ To clarify that the Amarillo bid was a retaliation for High Plains bid on Lubbock, Mercury tagged its rebid in Lubbock with ‘013’y. This strategy worked and High Plains backed off of Lubbock.’’23 The FCC fined Mercury $650,000 for making 13 codebids.24 While code-bidding makes communication with rivals easier, it is not essential for bidders to successfully signal to rivals in order to reduce the amount of bidding on specific licenses. Strategic bid placement and/or bid withdrawal can convey similar information. It is quite possible, for example, that White Plains would have understood the message from Mercury even without the three digit codes being attached to Mercury’s bids. Concerning the A and B block auctions, Cramton (1996, p. 21) writes, ‘‘one pair of withdrawals was apparently intended as a gift to entice a competitor to shift to the withdrawn licenses. In round 97, WirelessCo withdraw from Tampa and Houston, hoping that American Portable would take this gift and move off San Francisco. American Portable accepted the gift, moving down to Tampa and Houston in the next round. WirelessCo’s gift cost it $8.505 million in withdrawal penalties, but this was less than one bid increment in San Francisco.’’ What bidders were attempting was to reach an understanding with rivals as to which of them would get specific licenses without having to decide this through pushing the auction price too high.25 However, where tacit collusion does not result in disagreement among the parties during the auction, code and/or strategic bidding need not have appeared. In an effort to uncover whether ‘silent’ collusion may also have been important in the FCC auctions, Cramton and Schwartz used econometric techniques to discover that those guilty of bid signalling were as a whole successful in winning licenses at unusually low prices.26 Our ability to put a cost on collusion is severally limited, however, due to our inability to witness every instance. But it seems fair to say that for the DEF block auction, it was far greater than the $6 million to $14 million cost attributable to code-bidding alone (see footnote 25). The FCC has stated that its primary motivation for using auctions has not been their ability to generate revenue, but rather their ability to assign licenses to those firms which value them the 23
Cramton and Schwartz (1998, p. 7). The licenses in Lubbock sold for a little over $2 million. 25 In the DEF block auction, it has been estimated that the FCC lost between $6 million and $14 million due to code bidding and strategic retaliation. See Cramton and Schwartz (1998). 26 Reported in Cramton and Schwartz (1998). 24
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most. Where an auction is effected by collusion, however, those winning specific licenses or combinations of licenses need not be the firms which value those licenses the most. From auction 16 (which ended in December 1997) onward, the FCC has made several amendments to its auction rules which it considers should substantially reduce the risk of collusion in future auctions.27
7. Conclusion It seems highly unlikely that the FCC’s economic advisors or the FCC economists involved in the design of the auctions would not have been aware that problems might arise if: *
*
the auction payment rules were adjusted giving bidders, among other things, a lengthy window in which to exercise the default option, or the sale of the licenses in one block of spectrum was rushing through before technical and regulatory/legal rules could be finalised.
As for the C block licenses which fell under the control of the courts and US bankruptcy law, it seems that this was a genuine oversight on the part of the FCC, an organisation that has subsequently admitted, it has no great expertise in banking matters. If the auction designers had not been under political pressure to alter certain aspects of the auction and payment rules, the problems involving the C block auction (e.g. ‘excessive’ defaulting) or the poor revenue performance of the WCS auction, would not have occurred. The same cannot be said about the incidence of collusion among bidders. Some level of tacit collusion was present in a number of auctions, but in none of them does it appear that the overall efficacy of the auction was undermined. Further, amendments to the rules for future auctions have made collusion more difficult. But for those who think that by not using auctions to assign licenses they are avoiding collusion, think again. The incentive for rivals to collude in ‘competitions’, where the winners of extremely valuable rights to assets are being decided, is powerful, and it is perhaps only the personal morality of individual agents, or the threat of being caught, that prevents collusion in any particular case. In more traditional sealed bid tenders, there appears to be ample evidence that collusion has been widespread in the US and Europe, particularly for government or municipal licenses or contracts.28 Moreover, where refinements to SMR auction design make tacit collusion difficult to enforce during the auction, it seems likely that rivals may look again at methods of express collusion, much as can and does occur with sealed bid tenders. 7.1. So what lessons can the rest of the World learn from the US experience? The main message is that taken as a whole, spectrum auctions in the US have been a great success. As at 25 March 1998, which is about the end of the reportedly problematic licensing period, 5893 licenses had been auctioned with winning bids totalling $23 billion. (As of February 27 Although the level of communication with code-bidding seems direct enough for it to be a violation of general competition law, many attempts to collude could not be successfully prosecuted under competition law. For example, cases of strategic bid withdrawal, such as by WirelessCo, are unlikely to result in the courts finding a competition law violation. 28 See McAfee and McMillan (1992, pp. 579–599).
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2001 this amount had reached $41 billion). Defaulting has in fact been minimal, and in any event instalment payment schemes are no longer used. Prior to the adoption of auctions as the primary mechanism for spectrum assignment in the US, it had taken on average 720 days to get spectrum assigned under earlier beauty contests and 412 days under the lottery system. Using auctions the FCC has averaged 233 days from the filing of application until the license is actually granted, Moreover, with few exceptions the auctions will have put spectrum in the hands of the highest value users, something which no other assignment method can claim. Finally, the difficulties experienced in the US which were discussed in this paper, suggest that what other countries need to avoid is not auctions, but political interference which ties the hands of the auction designers. 7.1.1. Postscript Since this paper was drafted, there has been a downturn in the economic outlook for most businesses, including telecommunications companies. In the EU, several of the operators that have acquired 3G licenses now find their debt to market value to be uncomfortably high, and have been lobbying EU and individual country officials and politicians in an effort to get some relief. Judging by media reports, the main point lobbyists appear to have made is that the 3G auctions ‘held up’ operators for ransom, and the resulting debts will substantially delay the rollout of 3G infrastructure and thereby put back the economic development of the EU.29 The present time seems opportune for policy economists to critique these arguments, much as this paper has done in regard to events that took place in the auctioning of PCS licenses in the US Acknowledgements The author wishes to thank Evan Kwerel (FCC) and John McMillan (Stanford University) for information and advice they gave him in 1997/1998 relating to the issues discussed in this paper. He also wishes to thank Lorenz Nett of WIK for more recent comments. Incidentally, WIK was responsible for the policy advice, auction design and operating systems used for the 3G auction in Germany. The usual disclaimer applies.
References Bulow, J., & Klemperer, P. (1996). Auctions Versus Negotiations. American Economic Review, 86(1), 180–194. Congressional Budget Office Report (1997). Where Do We Go From Here? The FCC Auctions and the Future of Radio Spectrum Management. Cramton, P. (1996). The FCC spectrum auctions: An early assessment, Mimeo, University of Maryland.
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Recent examples of reports in the press can be found in the following: For examples of reports about excessive license fees see Europe Asks, 3G or not 3G? by Matt Hilburn, 30 January 2001, http://www.wired.com/news/technology/ 0,1282,41481,00.html, and the letter to the editor in reply to this issue by Ken Binmore (University College, London) one of the economists who assisted in designing the UK’s 3G auction ( http://www.guardianunlimited.co.uk/letters/ story/0,3604,434417,00.html). Overbidding for 3G licenses in Europe was reported by Dan Milmo, Media Guardian, 29 January 2001 (See, http://www.mediaguardian.co.uk/city/story/0,7497,430344,00.html).
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