Impact of Right of First Refusal on Land Market Regulation and Prices

While the Right of First Refusal can benefit tenants and local farmers, it can have unintended consequences on competitive bidding, market competition, and prices.

FREMONT, CA: In the context of escalating farmland prices, various land market regulation measures have been implemented, with preemption rights for tenants, neighboring farms, and the state stands out as prominent mechanisms. Professional and state sellers have adopted tendering procedures and auctions as cost-effective methods to identify buyers with the highest willingness to pay. However, auctions may lead to higher prices compared to search market outcomes. To address concerns about inflated prices for local farmers in privatization auctions, favoritism measures, such as restricted auctions catering to specific bidder groups like organic and young farmers, have been introduced. One such measure is the Right of First Refusal (RFR), which allows tenants to purchase leased land at the highest bid. According to Land Economics, RFRs can have unintended consequences, impacting other bidders and influencing price dynamics.

Effects on competitive bidding and market competition: Granting RFRs to tenants removes their incentive to submit competitive bids, affecting the bidding strategies of non-right holders. In non-RFR auctions, bidders compete against anticipated shaded bids, but in RFR auctions, they must bid against the valuation of the right holder. This reduces the chances of non-right holders winning and limits the expansion opportunities and collateral for other farmers, particularly young and start-up farmers. Additionally, non-farmer buyers, such as investors, may be discouraged from participating. The absence of competitive bids from the right holder and potentially deterred bidders leads to less competition, resulting in lower prices for public sellers and potential losses compared to non-RFR auctions.

Price effects and bidding behavior: The adapted bidding behavior of non-right holders in RFR auctions can have further price effects. Asymmetric bidder structures, risk neutrality, and varying risk aversion may favor the right holder as the weaker bidder. Research suggests that non-right holders may bid more aggressively in response. While reduced competition would suggest lower prices in RFR auctions, the increased aggression in bidding may counteract this effect, potentially leading to higher prices.

Impact on bidding strategies and entry barriers: Granting RFRs allows the right holder to acquire the land by paying the highest price non-right holders offer. This removes the right holder's need to participate in the price discovery process, disrupting simultaneous bidding strategies. Non-right holders can only acquire the land if their bids exceed the right holder's valuation, unlike in standard first-price auctions where competitors bid against the shaded bid. This disadvantageous situation for non-right holders reduces their expected profits and creates a negative externality. As a result, the RFR may deter non-right holders from participating, creating a barrier to entry. The potential costs of bid preparation and information gathering may outweigh the already reduced expected profits for non-right holders, leading to their reluctance to bid against an insider holding the RFR.

The absence of competitive bids from the right holder and potential deterrence of non-right holders may result in lower prices for public sellers. Still, the adapted bidding behavior of non-right holders can counteract this effect. Furthermore, the RFR can create barriers to entry and discourage non-right holders from participating, impacting market dynamics. Understanding the implications of the RFR on land market regulation and prices is crucial for policymakers and stakeholders in the agricultural sector.