Private property, economic efficiency, and spectrum policy in the wake of the C block auction.

• Author: Fritts, Brian C.

But if some of the consequences of his action are outside of the sphere of the benefits he is entitled to reap and of the drawbacks that are put to his debit, he will not bother in his planning about all the effects of his action. He will disregard those benefits which do not increase his own satisfaction and those costs which do not burden him. His conduct will deviate from the line which it would have followed if the laws were better adjusted to the economic objectives of private ownership.(1)

1. INTRODUCTION

   The most efficient means of distribution of scarce goods is private ownership. When private ownership is either expressly allowed or government-use rules closely resemble private property, the good is put to its most highly valued use. Rules of private property are especially necessary when valuation of the commodity is unclear. When the efficiency of private property exists, holders of goods must account for the goods' costs. The failure to create efficient rules by financing outside of private capital markets and the failure to properly institute property rights in spectrum created the current problems with the C block spectrum auctioned off by the Federal Communications Commission (FCC or Commission).

   As part of the 1993 Budget Act, the FCC was given the power to use auctions in awarding licenses for spectrum use.(2) The original C block spectrum auctions began December 18, 1995, and concluded May 6, 1996.(3) The C block auction was for a designated portion of the spectrum called Personal Communications Services (PCS). Personal Communications Services networks provide users with wireless data transmissions, voice transmissions, and electronic mail. Personal Communications Services is expected to offer less expensive services with stronger connections.(4)

   Unlike the previous A and B block auction, reserved and dominated by large bidders such as PrimeCo, Sprint Corporation, and AT&T Corporation, the C block auction was unique because it targeted smaller businesses that, in some cases, outbid large bidders by up to three times the A and B block amount.(5) In the short term, the C block auction appeared a resounding success. By offering favorable terms to those companies qualifying under FCC guidelines as a small business, the bidding resulted in a frenzy that drove up auction revenue. By the time the C block auction concluded, the total amount bid for the C block was $10.2 billion.(6) This was more than double the revenue of the A and B blocks combined.(7) For reasons explained in this Note, the A and B block licensees paid an average price of $16 per person covered in a territory (POP), while C block licensees bid more than $40 per POP for a winning spectrum bid.(8)

   While C block participants bid higher prices for spectrum., big bidders who entered the market first achieved greater economies of scale than newer companies. For instance, it was estimated that Sprint may have a 30 percent cost advantage over smaller companies.(9) This advantage is accomplished because a company like Sprint can use national advertising at 50 percent the cost per viewer than a smaller company using local advertising.(10) Economies of scale are not the sole problem for small bidders. Even though conditions in the capital markets have been favorable, there was a 70 percent plunge in values of comparable debt and equity issuers.(11) Wall Street analysts have estimated the fair market value of the C block at $10 per POP, making it difficult for small bidders to raise the funds needed to build the necessary infrastructure for their networks.(12)

   This led to the current problem. The C block rules required only a 10 percent down payment and then allowed payments to be made over ten years.(13) When those payments came due, C block licensees had trouble meeting their obligations. In fact, three bidders filed for Chapter 11 bankruptcy protection. General Wireless, which sought Chapter 11 protection, still owes the FCC over $953.6 million for its PCS licenses,(14) Pocket Communications, Inc., which bid $1.4 billion, asked for federal protection in March of 1996,(15) and NextWave filed for bankruptcy protection on June 8, 1998.(16) This turn of events concerning the C block forced the FCC to offer a plan for auction winners to return spectrum to the FCC if necessary. This spectrum was reauctioned in March 1999.(17)

   This Note argues that the primary focus of the FCC should be the efficient distribution of property rights in spectrum. Efficiency in this context means spectrum should be placed into the hands of the company or person who values it most. This implies that the only goals of the FCC should be to conduct auctions in an efficient manner and to grant winners an ownership interest equivalent to private property that will be enforced by the FCC.(18) The C block auction demonstrates the difficulties that are encountered when the FCC deviates from efficiency as a standard.

   To properly discuss the relationship between efficiency, the FCC, and spectrum policy, there are several issues that must be raised. First, why did the FCC first move to an auction format to distribute spectrum? Second, what goals was the FCC trying to accomplish by giving advantages to small businesses? Third, what went wrong with the auction, and what attempts have been made to fix it? This Note next suggests ways to fix the C block problem within the given framework. Lastly, what exactly is efficiency, how does it relate to a value-driven policy, and what would an efficient spectrum policy look like? This Note's contention is that the best and most efficient means of distributing the spectrum is an auction where payment is required shortly after the winning bid is selected. Efficiency requires that the highest bidder win the auction and that spectrum rights be transmissible. It is this Note's contention that efficient spectrum policy requires broadening property rights related to spectrum. This would include the right to use the spectrum in whatever manner the owner deems to be in his or her best interest.

2. A BRIEF HISTORY OF FCC DISTRIBUTION OF SPECTRUM(19)

   1. Comparative Hearings and Lotteries

      Not all spectrum is available for public use. "Frequencies in the radio spectrum are divided between federal and nonfederal use."(20) While the National Telecommunications and Information Administration (NTIA) allocates and assigns spectrum to federal users, the FCC has the responsibility of managing the nonfederal part of the spectrum.(21) For a long period of time, the FCC managed and distributed the spectrum by means of comparative hearings.(22) Comparative hearings employed a standard of the "public interest, convenience, or necessity" in granting spectrum licenses.(23)

      The advantage of a comparative hearing was that it gave an applicant a quasi-judicial forum to argue its qualifications for spectrum over competitors.(24) However, the hearing also had the drawback of being inefficient. First, no guarantee existed that the competitor who valued the spectrum most would be awarded it. Second, the procedure was costly to administer. For example, original licenses for cellular services were awarded by comparative hearings. Cellular services were in high demand since they were a scarce resource. The FCC received over 200 requests for the first thirty licenses.(25) Many of these requests contained over 1,000 pages of documentation and arguments supporting their claims for licensure.(26)

      The next round of licensing garnered 344 applicants, while the third round attracted 567 applicants.(27) The Commission's resources, especially its time, were strained by the daunting task of reviewing and evaluating applications in an equitable manner. Delay was also a problem during the evaluation process. The process could last longer than two years, causing large opportunity costs. These problems forced the FCC to consider lottery assignments of spectrum as a superior distribution method and to ask Congress for that authority.(28)

      In 1981, section 309(i) was included in the Communications Act.(29) The process of a lottery was meant to make the distribution process cost less while also taking less time than comparative hearings.(30) The problem with the lottery system adopted by the FCC, however, was that any person or entity could submit an application if it paid the application fee and met minimal requirements.(31) After applications were submitted, the FCC would select the winner of the license at random. Such a system immediately encouraged speculation by those not interested in creating cellular phone systems. Because the FCC abandoned its application screening process in 1987, almost 400,000 firms claimed to provide spectrum in order to obtain licenses.(32)

      A significant secondary market emerged from the lottery system used by the FCC. While the initial license almost never went to the entity that valued it most, the absence of anti-trafficking restrictions eventually allowed the market to allocate licenses to the most valued user. This secondary transaction created a large incentive for rent seeking regarding the windfall profits that could be made on a secondary sale.(33) The price of an application being low, a large incentive for speculation was reaffirmed.

      Despite these drawbacks, there is a part of the lottery system that was efficient--eventually licenses went to firms that valued them most. The downside, what made the lottery inefficient, was transaction costs associated with the process. Transaction costs for the year 1991 were estimated to be $190 million.(34) The main cost was associated with the time it took the license to be delivered to its highest valued user. On average, this was about two years.(35) Since during the delay, the eventual user/customer was denied service, the social cost of the lottery system was quite high. One estimation of social cost for the ten-year delay in licensing of cellular providers was 2 percent of Gross National Product...