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

Abstract

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.

Circulation Expectations, Farmer Trust, and Farmers’ Contract Choice Behavior

“…Verbal agreements typically require communication and interaction, which contribute to enhanced mutual understanding and foster a sense of trust between the parties involved. Farmers' preference for verbal contracts stems from the trust relationship they have established with the transferee [41], as they believe that both parties will honor the verbal agreements.…”

Empirical Industrial Organization Economics to Analyze Developing Country Food Value Chains

“…Deploying structural techniques to estimate contracting problems, and integrating them into analysis typical in EIO, are promising areas for future work. The literature provides a few examples, e.g., Ryan's (2020) analysis of contract renegotiation in procurement auctions, Galenianos & Gavazza's (2017) empirical model of a market with moral hazard and search problems that borrows from the structural literature in labor economics, and Igami & Sugaya's (2022) application of DICCs to the empirical study of a cartel. Much remains to be done at the intersection of (relational) contracting and EIO.…”

Relational Contracts and Development

“…24 Two recent contributions in the industrial organization literature are particularly relevant for the approach reviewed above. Ryan (2020) studies the consequences of lack of contract enforcement in the procurement of large power projects in India. Renegotiation of contracts in response to cost shocks is widespread (although bidders are allowed to bid cost-indexed contracts).…”