June 1, 2000

Auctions and precautions: overbidding in spectrum auctions and its possible impact

Recently there has been a huge interest within European governments and telecommunications firms in the auctions for third generation (UMTS) mobile licenses. This paper looks closely at claims by the incumbents that auctions will result in higher costs to consumers.

Within standard theory we find that unless firms are able to bid above the level of profits in the subsequent market, the optimal non-auction price and quantities will be unchanged. As standard theory does not account for such bidding, other non-standard possibilities for overbidding or post-profit bidding such as: differing pricing strategies, managerial incentives or reputation effects are considered. We find that although there is some likelihood of overbidding and inefficient price and quantity outcomes, this likelihood is small where the auction has been designed carefully, in particular where there are as many licenses as incumbents. In conclusion, we believe the benefits of an auction derived from ensuring the most efficient firm receives the license, will outweigh any small costs of overbidding as long as the government is able to ensure a non-collusive post auction market.