We had earlier argued that land acquisition transactions between farmers and private parties suffer from ?asymmetric information,? i.e., the private party having better information about the value of growth opportunities from land. This situation resembles a firm approaching financial markets for financing, where the firm?s managers are more informed about its growth opportunities when compared to its investors. Further, we had pointed out the use of hybrid securities, i.e., securities combining features of debt and equity, to mitigate the problem this asymmetric information problem in financial markets. Since the land acquisition transaction suffers from problems stemming from asymmetric information, as in the corporate finance context, the payment made to land-owning farmers must involve features of debt and equity. This can be implemented in the following way. Instead of paying them the Haryana model of fixed annuity payments, which is the payoff associated with debt securities, the amount paid on the annuity every year should be indexed to the price of land in the particular area.
Say a farmer parts with one square metre of land whose price is Rs 100 currently. He, of course, needs to be paid Rs 100 now. Further, he is also entitled to a stream of payments over the next 33 years, where the payment is indexed to the price of that one square metre of land. For example, say that the price of this one square metre of land increases to Rs 500 next year, Rs 700 the second year and Rs 800 the third year. I propose that the farmer be paid half the value of the increase in the price of the land or Rs 200, Rs 100 and Rs 50 in the first, second and third years.
Paying him half the increase in real estate price is fair since both the landowner and the private entity putting up the factory or developing the area have contributed to increasing the price of that piece of land. Since real estate prices are well-known among buyers and sellers, both the private party and the farmer should be able to find out the appropriate price prevailing in their area every year. In a few years, rating agencies along the lines of CRISIL/ICRA can start publishing on the web the real estate prices for each geographical area in India. Such public data is available in the US. With the aid of Google maps, this exercise can be accomplished for India as well.
Will this payment policy render unprofitable the potential projects planned by private parties? To answer this question, note that the profits the private party derives should be commensurate to the value added by the private party. In the above solution that I have proposed, the private party obtains half the gains in the market price of land. The private party also generates profits from the industrial activity for which the land was acquired. For example, the auto manufacturer that acquired the land generates profits from auto sales. But this solution will not provide the private party super-normal profits that are currently generated by depriving the farmer the value from land price gains.
In the corporate finance context, potential investors can refuse to invest in a firm when the stream of future payments offered to the investor does not compensate the investor for the uncertainty about future growth opportunities. However, in the land acquisition context, this option to refuse does not rest with an individual land owner; yes, in some cases, these landowners join hands, agitate and thereby acquire the power to exercise this option to refuse. But these may be the exception rather than the norm since collective action is not easy to bring about. Since the option to refuse may not exist with an individual farmer in most cases, the payment to the farmer needs to be designed so that the landowner is provided the fair price. Crucially, the fair price needs to take into account not only the current price of the land but also the present value of future growth opportunities that can be generated using the land. Therefore, in framing the land acquisition Bill, the government needs to provide farmers the fair price as described above so that the farmer does not get cheated.
This solution does not prescribe different prices for land acquisition by the government and private parties. Such differences will only encourage corrupt practices in land acquisition among the bureaucrats and politicians. Given the difference in prices, private parties will surely have the temptation to bribe bureaucrats and politicians so that the land can be acquired by the government and then sold to the private party.
(Concluded)
The author teaches finance at the Indian School of Business, Hyderabad