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In recent years several countries have started massive highway franchising programs auctioned to private firms. In these auctions, the regulator typically sets the franchise term and firms bid on tolls or, alternatively, the regulator sets tolls and the winner is the firm that asks for the shortest franchise term. In both cases, the franchise term is fixed before the franchise begins. In this paper we propose a new auction mechanism, where the regulator sets the toll schedule and the firm that bids the least present value of toll revenue wins the franchise. With this scheme the franchise length adjusts endogenously to demand realizations. Assuming that the regulator is not allowed to make transfers to the franchise holder, and that firms are unable to diversify risk completely, we characterize the full information optimal contract and show that it can be implemented with a Least-Present-Value-of-Revenue (LPVR) auction. Furthermore, for demand uncertainty and risk aversion parameters typical of developing countries, welfare gains associated with sub-stituting an LPVR for a fixed-term auction are large (e.g., one third of the cost of the highway).
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