Academic journal article Economic Inquiry

Potential Competition and Possible Collusion in Forest Service Timber Auctions

Academic journal article Economic Inquiry

Potential Competition and Possible Collusion in Forest Service Timber Auctions

Article excerpt

I. INTRODUCTION

Potential entrants to an imperfectly competitive market, in theory, limit the ability of existing firms to charge high prices. This claim has rarely been tested, due mainly to the problems of identifying potential entrants and determining whether established firms perceive them as future competition. In previous work, Neal [1987] finds option bid-ask spreads lower when they are eligible for multiple listing, Kuhlman and Johnson [1983] find winning highway construction bids insignificantly related to the number of firms buying plans for the particular project, and Hurdle et al. [1989] show that performance in the airline industry is affected by the number of potential entrants not deterred by economies of scale or scope.

This paper determines whether potential competition influenced winning bids in Forest Service oral and sealed-bid timber auctions held during 1977. Prior to 1977 oral bidding was the dominant method of selling timber in the Pacific Northwest. The National Forest Management Act of 1976 required that sealed bidding be used on all sales with exceptions made only by the Secretary of Agriculture. The sealed bidding requirement was overturned in 1978 after firms in communities dependent upon Forest Service timber complained that sealed bidding resulted in greater uncertainty in obtaining steady timber supplies.(1) Firms pay the government for the rights to harvest timber in Forest Service timber auctions and the highest bid wins. Bidding theory predicts that greater competition should result in higher winning bids.(2) The relevant measure of competition in an oral auction is the actual number of competitive bidders. Participants in a sealed-bid auction, however, should base their bids on the potential number of competitors.

Timber is costly to haul and timber transportation distances, from the sale site to the closest mill of potential competitors, are used to define two measures of potential competition. The first measure is a simple count of the number of firms whose closest mill lies within the geographical market for Forest Service timber auctions and is termed potential competition. The second results from a probit analysis relating auction participation to hauling distance and is called expected competition.

The results show that these measures are, as expected, considerably more important in explaining winning sealed bids. However, actual competition explains winning bids better than either potential or expected competition under both oral and sealed bidding. In addition, contrary to expectations, increases in hauling distances result in higher winning bids when sealed bidding is used.

Collusion in sealed-bid auctions and preclusive bidding (a type of collusion) in oral auctions are explanations for both of these results. The possibility of collusion in sealed-bid auctions is supported by an index, based on Stigler's [1964] theory of oligopoly and Feinstein, Block and Nold's [1985] research on bid-rigging in highway construction auctions, representing the likelihood that a given auction was rigged.

Mead [1966] was among the first to discuss the possibility of preclusive bidding in oral auctions. Preclusive bidding occurs when firms close to a sale site bid above levels which are profitable to firms farther from the site. Given that oral bidding entails greater participation costs (participants must be present), preclusive bidding or the threat of preclusive bidding deters outsider firms from bidding in future oral auctions. Firms close to the site benefit from the decreased competition and may win at a lower price. Oral and sealed-bid comparisons of winning bid variances, overbids, and numbers of bidders support the explanation of preclusive bidding in oral auctions.

Public policy should be concerned with obtaining the highest possible value for public timber and ensuring that it is awarded efficiently, to the firm having the highest timber value. …

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