Negotiations over mineral extraction titles with bilateral asymmetric information: the case of developing countries

Abstract

Why do negotiations between governments of developing countries and multinational mining companies often yield inefficient trade over acquisitions of mineral extraction titles? Adverse selection is one of the main reasons. When the terms of contracts are prepared on the basis of erroneous information, the resulting contract will be inefficient. This paper presents a theoretical model of negotiations over mineral extraction titles with bilateral asymmetric information; where a mining extraction title is negotiated between a developing country’s government and a multinational mining company. When both the mine owner and the mine operator have private information at the time of trading, and when each contracting party has a continuous distribution of types, with strictly positive density function, trade inefficiency is the inevitable result. However, it is still possible to reduce the inefficiency if the agents’ valuations are traded at auction, or if they resort to arbitration. Therefore, as a second-best optimal contract, two strategies remain possible; the simple double auction or the final offer arbitration. In both strategies, the average price bid amount is the optimal result of the negotiation.