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Business News/ Opinion / Liberalized spectrum management
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Liberalized spectrum management

Sometimes giving more freedom to the holder of an asset can reduce its value. This is true of spectrum too

Photo: Hemant Mishra/MintPremium
Photo: Hemant Mishra/Mint

Since Ronald Coase’s seminal analysis of property rights in radio spectrum in 1959, economists have advanced the notion that liberalizing the rights held by wireless users would expand social welfare. The market allocation of radio spectrum, which requires exclusive ownership of radio waves, is increasingly acknowledged to be superior to administrative planning mechanisms pejoratively referenced as command and control. India has moved toward a liberalized regime of spectrum management by adopting an auction-based allocation procedure, giving flexibility on the services offered and technologies used, and permitting the sharing and trading of spectrum.

The forthcoming auction of 2,100 megahertz (MHz) spectrum in March is important not merely because of the expected impetus to the growth of 3G services in the country, but also on account of the revenues garnered to meet aggressive fiscal targets. The department of telecommunications (DoT) recently raised the reserve price of the auction.

Does the liberalization of spectrum increase its value? In the past, economists have argued that the terms of liberalization should be limited in order to increase the revenues from spectrum auctions. However, the relationship between liberalized property rights and the resulting value is an empirical one. A priori there are two possibilities: firstly, the availability of greater privileges in the licence increases the value of the licence; secondly, the greater level of competition possible on account of the liberalized regime could reduce the market power of the licensee and hence the value of the licence. For example, a licensee holding 1,800MHz spectrum, previously limited to 2G services, could deploy 4G technology to challenge holders of 2,100MHz on high-speed data services. This would reduce the value of 2,100MHz spectrum.

An important aspect of liberalization relates to the enablement of secondary markets. Secondary markets again could have two kinds of effects on the value of the primary licence. They could increase the value as bidders feel secure that they can offload their asset on the secondary market if needed. On the other hand, they could reduce the value of the licence as bidders may bide their time given future options of getting the licence.

In a paper published in 2008, economist Thomas William Hazlett compiled a data set encompassing 42 licence auctions conducted in 27 different countries between 1995 and 2001. In aggregate, some 1,438 licence sales were observed. Wireless licence prices were assumed to be a function of the anticipated demand for wireless services, the industry structure, the cost of capital, the type of auction mechanism, the licence term, and the extent of the property rights embedded in the licence.

The analysis throws up interesting results: longer term licences may be associated with lower prices, which is counter-intuitive since one expects the cost of renewal to reduce licence value. However, this may be explained by an inverse commitment expectation under which licensees expect easier renewals with lower licence terms. The use of first price sealed bid auctions is shown to be associated with higher prices, a finding consistent with auction theory.

The coefficient of primary interest is the one associated with the variable used for liberalization. This is estimated to be negative and statistically significant. A licence sold in a liberal spectrum regime auction is valued at about 61% below a similar licence sold elsewhere. Over the period under consideration, profits gained from additional property rights appear to be more than offset by the anticipated reduction in value a more competitive market imposes on infra-marginal licence rights. This finding is inconsistent with the hypothesis that the windfall that licensees receive from expanded rights is unambiguously positive, and seems to validate the recommendation of economists on restricting licence rights for higher revenue.

The impact of the introduction of secondary markets in spectrum may not be relevant since such markets have not exhibited vigour in any jurisdiction and thus may not be a significant factor in bidders’ estimations. In a different context, empirical evidence on the pricing of initial public offerings (IPOs) indicates that IPOs are, on average, offered at prices that are below their subsequent secondary market trading prices. For example, over the period from 1960 to 1987, using data from the US stock market, Roger G. Ibbotson, Jody Sindelar and Jay R. Ritter report that average IPO underpricing is 16.37%. Explanations for this typically involve asymmetry of information between the issuer, the investment banker and the secondary market participant. For instance, one theory postulates that the investment banker is better informed about the demand for the new issue than the issuer. To compensate the investment banker for his superior knowledge, the optimal contract between the issuer and the investment banker results in underpricing.

While the results of Hazlett’s paper cannot be generalized blindly, the model’s findings are important in demonstrating the ambiguous nature of the windfalls associated with spectrum liberalization, and the determination of the reserve price. The opposition of incumbents in the European Union to liberalize spectrum use seems to bear out the interesting observation that, sometimes, giving more freedom to the holder of an asset can reduce its value. The designers of spectrum auctions in India need to keep this possibility in mind.

Rohit Prasad is an associate professor of economics at MDI, Gurgaon.

Comments are welcome at theirview@livemint.com

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Published: 22 Feb 2015, 11:50 PM IST
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