Finance Research Letters xxx (xxxx) xxx

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Finance Research Letters

journal homepage: www.elsevier.com/locate/frl

Financing land acquisition for infrastructure projects

Bhagwan Chowdhry ∗,1
Indian School of Business (ISB), India
University of California, Los Angeles, United States of America

ARTICLE INFO ABSTRACT

Keywords: Land acquisition for infrastructure projects that require a large amount of funding can be
Infrastructure financed with an equity-like protocol. The auction protocol does not require knowledge of
Equity the reservation value of the land acquired, nor does it require determination of the post-
Financing
development value of the land in the surrounding area. Competition among private players
Externalities
transfers the value of pecuniary externalities, manifested in land price appreciation, to the
Land
government, which it can use to partially finance the project.

1. Introduction

Financing large scale projects such as airports, railways, roads, and bridges require big financial outlays and the benefits that
accrue are widespread and often not easy to monetize. It is often assumed that governments are responsible for developing and
financing such projects. But the government may not have sufficient tax revenues to fund such projects. Private lenders may be
reluctant to loan money to the government for very long-term projects in which revenues may not be realized for very long periods
or at all in the case that the government fails to complete the project. This also rules out any cash auctions by the government. In
this paper, I consider an equity-like alternative for infrastructure financing.
It is well-known that many infrastructure projects lead to economic development in areas adjacent to the project, which leads to
price appreciation of land.2 In fact, many insiders, including politicians, often receive illegal kickbacks from private developers who
are tipped off in advance about the locations of large infrastructure projects. Developers acquire land at throwaway prices which
ultimately increase in value several-fold after the project is announced and developed.3
I show that the government could formalize a fair and transparent process of selecting the project location that encourages
developers at competing locations to bid for the right to host the project. The government can then use the funds thus raised in
the auction to finance the project, at least partially. Indeed, Peterson (2009), writes, ‘‘Land has a long history as an instrument of
urban infrastructure finance’’. He provides several examples of infrastructure financing by various governments in New York, Paris,
Cairo, Bogota, Bangalore, Mumbai, Cape Town among others.

∗ Correspondence to: Indian School of Business (ISB), India.

E-mail address: bhagwan@isb.edu.
1 I thank Shashwat Alok, Ashwini Chhatre, Parikshit Ghosh, Meenakshi Sinha, Krishnamurthy Subrahamanian and my other colleagues in Finance, Economics
and Public Policy at the Indian School of Business for many useful discussions. Three anonymous referees provided many useful and detailed suggestions including
a correction in one of the proofs. I thank Paheli Desai-Chowdhry for copy-editing the final draft.
2 Katherine Sierra, Vice President, Sustainable Development, The World Bank, in Foreword to Peterson (2009) writes: ‘‘Land values are highly sensitive to

infrastructure investment and urban economic growth. Public works projects such as road construction, water supply, and mass transit investment produce
benefits that are immediately capitalized into surrounding land values’’.
3 Sinha (2018) discusses a real-estate cross subsidization model for urban development. In a recent book The Billionaire Raj, the author, James Crabtree, who

spent five years in India as Mumbai bureau chief for the Financial Times, alleges that these types of arrangements were commonplace in many parts of India
during the last few decades - Crabtree (2018).

https://doi.org/10.1016/j.frl.2021.102656
Received 26 June 2021; Received in revised form 14 December 2021; Accepted 27 December 2021
Available online 18 January 2022
1544-6123/© 2022 Elsevier Inc. All rights reserved.

Please cite this article as: Bhagwan Chowdhry, Finance Research Letters, https://doi.org/10.1016/j.frl.2021.102656
B. Chowdhry Finance Research Letters xxx (xxxx) xxx

The issue of just compensation for ‘‘eminent domain’’ has been discussed persuasively by Ghatak and Ghosh (2011) and the
ideas I develop in my model are influenced by their insights. The central insight that I develop with the help of a simple model is
to demonstrate that the determination of the fair value of land without the project is not necessary in the auction protocol.
In related literature, DeMarzo et al. (2005) provide rigorous modeling of security design in which the bidders use securities,
rather than cash. This is indeed quite common in Mergers and Acquisitions. Skrzypacz (2013) provides an overview of models of
auctions with contingent payments. The auction protocol that I describe also uses equity-like payment, not cash. My results, however,
are not derived as the optimal auction mechanism — my results should be viewed as plausible. A rigorous derivation would require
a deeper, more expansive analysis.

2. The auction protocol

Let me first describe the protocol for raising funds for an infrastructure project:

1. The government announces an infrastructure project that would require 𝐿 acres of land.
2. Competing landowners offer 𝐿 acres for the infrastructure project to the government with a plan to develop several hundred
more acres of the surrounding area they own that will now have a higher value.
3. Each bidding landowner divides the surrounding area into 100 parcels and offers a fraction of these 100 parcels, say 40, 50,
or 60 of them, to the government.
4. The government randomly picks these parcels out of the 100 and the developer keeps the remaining parcels.
5. The government picks the bid that offers the largest area of land surrounding the project.
6. The government can subsequently sell some of the parcels it gets in the open market (and perhaps lease others) and use the
funds raised to partially finance the construction of the project.

3. The model

Consider an infrastructure project that requires land with a circular area of

𝑙
𝐿= 2𝜋𝑟𝑑𝑟 = 𝜋𝑙2
∫0
where 𝑙 is the radius of the circle. Let 𝑝 denote the price per unit of a parcel of land where this project could be built and let 𝑣 ≥ 𝑝
denote the private valuation per unit of the land that is owned by a landowner. Clearly, 𝑣 cannot be less that the market price, or
else the landowner would have sold the land.4 Let 𝑏 > 𝑙 denote the radius of the land that will be acquired. The inner circle of radius
𝑙 will be used for the project, and the area around that circle up to radius 𝑏, the boundary, will be developed by the landowner
(who may, in turn, have purchased the land from several other smaller landowners).5 Let 𝑐 denote the per unit cost of developing
the land and let 𝑃 (𝑟) denote the price per unit of the land after development that is at distance 𝑟 from the center of the project. I
assume that farther the distance from the center, the lower the price after development will be. That is

𝑃 ′ (𝑟) < 0. (1)

It will be worthwhile to develop the land up to the boundary radius 𝑏 such that

𝑃 (𝑏) = 𝑣 + 𝑐. (2)

Lemma 1. The higher the private valuation 𝑣, the smaller the area that will be developed. That is

𝑏′ (𝑣) < 0.

Proof. Differentiating (2) with respect to 𝑣, we get

𝑃 ′ (𝑏)𝑏′ (𝑣) = 1

and since 𝑃 ′ (.) < 0 from (1), the result follows.

We will assume that there exist some landowners whose private valuation 𝑣 is small enough that

𝑏(𝑣) > 𝑙.

4 The market price 𝑝 reflects the value of the land in its current use plus perhaps some option value unrelated to the possible value increase from the specific

infrastructure project.
5 Arnott and Lewis (1979) is a seminal paper presenting a model of development in which a landowner chooses development ‘‘at the time and density which

maximize the present value of his land’’.

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Fig. 1.

In words, this means that there is some area around the project where the price per unit after development will be higher than 𝑣
after accounting for the cost of development 𝑐.6 It is easy to see that 𝑏 will be finite. The total market value of the developed land
in the ring surrounding the project then will be:
𝑏(𝑣)
𝑉 (𝑣) = 2𝜋𝑟𝑃 (𝑟)𝑑𝑟
∫𝑙
and the cost of developing that piece of land plus its foregone private value will be
𝑏(𝑣)
𝐶(𝑣) = (𝑐 + 𝑣) 2𝜋𝑟𝑑𝑟.
∫𝑙
It is easy to see that the total value created from developing the ring of land around the project is
𝑏(𝑣)
𝛥(𝑣) = 𝑉 (𝑣) − 𝐶(𝑣) = 2𝜋𝑟[𝑃 (𝑟) − (𝑐 + 𝑣)]𝑑𝑟 > 0 (3)
∫𝑙
since for 𝑟 < 𝑏(𝑣),
𝑃 (𝑟) > 𝑐 + 𝑣.

Lemma 2. The higher is the private valuation 𝑣, the smaller is the total value created, 𝛥(𝑣), that is
𝛥′ (𝑣) < 0.

Proof. Differentiating (3) with respect to 𝑣, we get

[ ]
𝑏(𝑣)
𝛥′ (𝑣) = 2𝜋𝑟[−1]𝑑𝑟 + 𝑏′ (𝑣)2𝜋𝑏(𝑣)[𝑃 (𝑏(𝑣)) − (𝑐 + 𝑣)] < 0
∫𝑙

since the first term above is negative and the second term is zero from (2).
Suppose the landowner offers a fraction 𝑓 of the developed ring of land in addition to the central area 𝐿 for the project to the
government in exchange for keeping the remaining fraction (1 − 𝑓 ) of the developed ring of land, of value (1 − 𝑓 )𝑉 (𝑣), for herself.
The total cost of developing the ring of land plus the forgone private value of the land to the landowner is:
𝐿𝑣 + 𝐶(𝑣).

6 This may not always be the case if the project generates noise, pollution or other negative externalities. However, for many projects, such as airports, the

net benefit may still be positive, see Green (2007). Capozza and Helsley (1989) estimate: ‘‘In rapidly growing cities, the growth premium may easily account for
half of the average price of land and may create a large gap between the price of land at the boundary (minus conversion cost) and the value of agricultural
land rent’’.

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The landowner will be willing to make this trade only if:

(1 − 𝑓 )𝑉 (𝑣) ≥ 𝐿𝑣 + 𝐶(𝑣).

Rearranging, we get

𝑉 (𝑣) − 𝐶(𝑣) = 𝛥(𝑣) ≥ 𝐿𝑣 + 𝑓 𝑉 (𝑣).

The condition above states that the incremental value creation from developing the ring of land 𝛥(𝑣) must be greater than the sum
of the foregone private value of the land the landowner surrenders to the government for the project 𝐿𝑣 and the post development
value of the land the landowner offers to the government 𝑓 𝑉 (𝑣). Let 𝑓 ∗ denote the largest value of 𝑓 such that

𝛥(𝑣) = 𝐿𝑣 + 𝑓 ∗ 𝑉 (𝑣). (4)

Suppose there are multiple landowners with varying degrees of private valuations

𝑣 ∈ [𝑣0 , 𝑣].
̄

Proposition 1. The landowner with the smallest private valuation 𝑣0

1. will develop the largest land area around the project, that is will have the largest 𝑏0 = 𝑏(𝑣0 ),
2. will maximize the value of the land offered to the govt 𝑓 ∗ (𝑣0 )𝑉 (𝑣0 ).

Proof.

1. Follows from Lemma 1.

2. From (4), the developed area offered to the government,

𝑓 ∗ 𝑉 (𝑣) = 𝛥(𝑣) − 𝐿𝑣,

which is decreasing in 𝑣 from Lemma 2.

The landowner with the smallest 𝑣0 will thus win the bid.7

4. Discussion

There are a number of appealing features in the solution described in the model above:

1. The landowner receives fair compensation. This is because there is no coercion. Each landowner decides what is the private
value of land without the project, and makes a bid to be the site of the project accordingly. Notice that the landowner’s
private value 𝑣 may be higher than the market price 𝑝 - as is also the case in Ghatak and Ghosh (2011).
2. Because of competition among landowners, the increase in value generated by the project is captured entirely by the
government and can thus be used to fund the project to a maximum degree. When the project site selection is done in a
corrupt and non-transparent way by government officials in exchange for kickbacks, the value surplus may not be captured
fully.
3. It is the land that has the smallest alternative value 𝑣0 that would win the bid and be developed. This assures allocative
efficiency.
4. The winning bid generates the maximum amount of resources for the government.
5. The government need not know the value of the land post development. Because the land is shared between the landowner and
the government in a proportional equity-like way, fraction 𝑓 ∗ to the government and the fraction (1 − 𝑓 ∗ ) for the landowner,
the government is assured that the landowner, in maximizing their share of the developed land will also maximize the value
of the land allocated to the government.
6. The winning bid is easy to identify without ascertaining the value of the land post development. This is because the total
area offered to the government will be the largest for the landowner with the smallest private value 𝑣0 . The government can
thus simply pick the bid that offers the largest area to the government.
7. To ensure that the government is truly receiving fraction 𝑓 ∗ of the total value, it could ask the landowner to divide the ring
around the project in say 100 parts each of equal value. The government would then randomly pick 100𝑓 ∗ of these parts.
The landowner, not knowing which parts would be picked by the government and which parts it would retain, will try and
create 100 parcels that are of equal value. This protocol generalizes to the case in which the value of the land for any given
distance from the center may not be identical. The equi-value contour in this case need not be a Euclidean circle, but the
landowner should still be able to create 100 parcels of equal value.

7 A referee has pointed out that this appears to imply a First-Price auction mechanism without rigorously checking for the required regularity conditions. It

is possible that we will obtain a similar result using a Second-Price auction mechanism with a continuum of distribution for 𝑣 for landowners.

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8. The model assumes the landowner owns all the area around the project and is able to offer a fraction to the government. If
the landowner has to purchase several smaller land pieces from various smaller landowners before making a bid, it generates
some tricky issues. First, there may be a hold-out problem in which some small landowners refuse to offer their land unless
a substantial premium is offered. Formally, in our model, this will amount to raising the aggregate reservation valuation of
the land. This will make that piece of land less competitive than other locations where hold-out problems are not present.
This may dissuade smaller landowners from demanding a price that is substantially higher than their private valuation. The
key insight here is that competition among different locations for the project drives the surplus captured by them to zero.
9. An obvious question is why involve the government at all? Why not develop such projects entirely as private enterprises
as opposed to a public–private partnership? We have argued that creating large infra-structure projects generate substantial
amount of economic development. This economic development could be characterized as externalities. But there are two types
of externalities, pecuniary and non-pecuniary. While pecuniary externalities manifest themselves in land price appreciation,
which both the government and private agents can capture and then perhaps transfer to the government, the non-pecuniary
externalities cannot be easily monetized. Even though the non-pecuniary externalities cannot be monetized, the government
may value these on behalf of its citizens and therefore may supplement the cost of running the project from its tax revenues.
The protocol we have discussed lowers the cost of the project to the government by capturing the value of pecuniary
externalities, which may be substantial.
Furthermore, by giving an equity-like stake to the government, the landowners bidding for the project will be assured that
after the funding is raised, the government will continue to have an incentive to ensure that development does indeed take
place. Many public–private partnerships never come to fruition because private players are not convinced that the government
will follow through on their commitments. This is also why debt financing does not work and thus a cash auction will also
likely not work.
10. In the model, I only considered the case where development takes place horizontally. A generalization where the area is
developed vertically in the form of a multi-story building (think the Sears Tower in Chicago or the Empire State Building in
New York City) is straightforward.

5. Conclusion

In the auction protocol I have described in the model, the government does not need to know either the price of the land before
the bid or the private value that the landowner assigns to the land pre-development. The 2013 Land Acquisition Act in India8 sets
an arbitrary 4 times the market price – which is difficult to determine – and may not reflect the seller’s private valuation in any
case as fair compensation. It is the smallest value land that will see a largest total increase in value of the surrounding area from
the infrastructure project. Because value of the land in its current use is low (think of farms in Sonipat, Haryana, near Delhi), it
will benefit the most from development and the landowner who wins that bid will therefore develop the largest area around the
project and correspondingly offer the largest surrounding area to the government. The intuition for this result is that the relative
increase in value of the land will be less for areas that are already of high value (think, Connaught Place in Delhi or Banjara Hills
in Hyderabad). That is why we do not see new Universities and airports springing up in urban areas.
Similarly, the government does not need to know the post-development price and value of the surrounding land it receives.
This is because, in effect, it is receiving an equity partnership in the surrounding area that will increase in value post development.
Landowners making the offer will ensure that the value of the land they keep is as high as possible and, in the process, maximize
the value of the share received by the government as well. Competition among landowners ensures that the increase in value is
captured largely by the government and can thus be used to fund the infrastructure project to a maximum degree. Currently in
practice, the site selection is done arbitrarily, and is often offered to select developers in a corrupt way in exchange for kickbacks.
As a result, a substantial portion of the value surplus is lost. Having a skin-in-the-game also ensures that government as well as the
private players have incentives ex-post to maximize the value of the project.
The winning bid is easy to identify without estimating the value of the land post development. This is because the total area
offered to the government will be the largest for the landowner with the smallest current value of the land. The government can
thus simply pick the bid that offers the largest area to the government. Dividing the surrounding developed area into 100 parts and
giving the government the right to randomly pick parcels from those available ensures that government receives a fair fraction of
the increased value. The bidding landowners, not knowing which parcels would be picked by the government and which it would
retain, will try to create 100 parcels that are of equal value.
The central insight of my proposal is that we can design a fair and transparent bidding system that allows all private agents
to participate, and eliminate the arbitrary and often corrupt system that in effect steals the value of monetizable externalities and
distributes them among politicians and their cronies instead of using these to reduce the cost of the project for the taxpayer.

Declaration of competing interest

The authors declare that they have no known competing financial interests or personal relationships that could have appeared
to influence the work reported in this paper.

8 http://legislative.gov.in/sites/default/files/A2013-30.pdf

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Crabtree, James, 2018. The Billionaire Raj: A Journey through India’s New Gilded Age. HarperCollins.
DeMarzo, Peter M., Kremer, Ilan, Skrzypacz, Andrzej, 2005. Bidding with securities : Auctions and security design. Amer. Econ. Rev. 95, 936–959.
Ghatak, Maitreesh, Ghosh, Parikshit, 2011. The land acquisition bill: A critique and a proposal. Econ. Political Wkly. XLVI (41), 64–73.
Green, Richard K., 2007. Airports and economic development. Real Estate Econ. 35, 91–112.
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Sinha, Meenakshi, 2018. Ideas for India, real estate cross-subsidisation for infrastructure financing: A precarious solution for urban development? January 8.
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