Tata Power and the Winner’s Curse
It would not be better if things happened to men just as they wish.
~ Heraclitus of Ephesos
Markets are usually a good way to organize economic activity. While it is well-known that certain market structures such as a monopoly lead to inefficient allocation, even when conditions are ideal for a competitive outcome, there are instances when what economists call “information problems” lead to sub-optimal outcomes. Information problems could arise due to the lack of good information or due to certain parties having better information than other parties (i.e. asymmetric information). The winner’s curse is one such information problem that leads to sub-optimal allocation. The winner’s curse is defined as the tendency for the winning bid in an auction to exceed the intrinsic value or true worth of an item. Because of incomplete information, emotions or any other number of factors regarding the item being auctioned, bidders can have a difficult time determining the item’s intrinsic value. As a result, the largest overestimation of an item’s value ends up winning the auction. The term winner’s curse was coined as a result of companies over-bidding for offshoreoil drilling rights in the Gulf of Mexico. The winner’s curse is often accompanied by a situation in which there is competition (such as an auction) and when the value of victory can only be estimated in advance. To take an example of an auction for oil drilling rights which led to the study of the “winner’s curse”, the bidding oil companies have access to different surveys, with some making more optimistic estimates about the quantity of oil than others. However, while there are multiple estimates, there is only one true amount. The companies tend to bid accordance with the survey results that they have, and the company with the most optimistic survey will probably win the licence to drill as a result of quoting the maximum amount. Unless all surveys underestimate the amount of oil which is unlikely, the company that makes the winning bid will overpay. This, however, will be known only when the company starts drilling for oil thus leading to the “winner’s curse”. There are a variety of other situations in which competition has led to overpaying by the bid winners which has ultimately led to financial distress for the “winner”. In effect, by winning, the winner loses. Examples include bidding for a top player in sports, acquiring a company when there are multiple bidders, auctions for telecom spectrum and the acquisition of TV rights for films. In the Indian context, the bidding for Ultra Mega Power Projects (UMPPs) resulted in bids for unrealistically low power prices based with bidders assuming that they would be able to procure coal at low rates. When the price of coal went up, most of these projects including the ones by Tata Power and Adani Power began to bleed and resulted in heavy losses for the concerned companies.
UMPPs or Ultra Mega Power Projects were a series of large thermal power stations (each with a capacity of 4000 MW or above) envisaged by the Government of India in 2006 during the second term of the UPA government to tackle India’s chronic power shortage. Bidders bid very aggressively based on optimistic projections of the price of coal (which was low during the bid submission stage) and suffered losses when coal prices began to rise. Tata Power’s 4000MW Mundra power project was one of the UMPPs that suffered from the winner’s curse. By Q1 of 2017, Tata Power had accumulated losses of over Rs. 6400 Crore and was running the plant at 40 paise per unit loss (entailing an annual loss of over Rs. 1000 Crore). Tata Power approached the Central Electricity Regulatory Commission (CERC) to obtain relief through an increase in power tariffs and was granted partial relief through a small tariff hike. At one point, Tata Power was even contemplating selling the Mundra power project for a token amount of Rs. 1 to the Gujarat Urja Vikas Nigam which did not fructify. Thus, Tata Power’s Mundra UMPP serves as a reminder of what can go wrong with aggressive bids based on optimistic projections thus leading to the “winner’s curse”.