Public private partnerships: Incentives, risk transfer and real options

Private financing of large-scale infrastructure projects through public private partnerships (PPPs) has grown in recent decades. Together with changes in conventional construction procedures, there have been changes in the project financing model. The use of PPPs raises questions as to the role of the private sector in infrastructure provision and the conditions governing the long-term contractual relationships between the private and public sectors. In some early examples of PPPs, the government guaranteed a minimum profitability over the cash flows using a set of contractual terms which transferred some of the risk of the project from the private provider back to the government. Using a large toll road project, the Melbourne CityLink Project, as a case study we show how the imposed conditions can be treated as real options, how these options affect the incentive to invest and how the public sector may be transferring considerable value to the private sector through government guarantees.     

Pricing Final Indemnification Payments to Private Sponsors in Project-Financed Public-Private Partnerships: An Application of Real Options Valuation

The extraordinary global growth in the private funding of public infrastructure projects in the form of public‐private partnerships (or PPPs) is expected to have major social and economic benefits—benefits that result in large part from improving the allocation of project risks between the public and private sectors. But with the financial crisis and severe tightening of credit likely to limit the financing and delivery of new projects, both project participants and their financiers need to manage the technical, economic, legal, and political complexities of infrastructure projects more carefully, especially in less traditional infrastructure deals that involve complex operations, new assets, or emerging markets. This paper proposes and illustrates the application of the real options valuation approach to a critical feature of most PPPs: establishing the final “indemnification” amount to be paid by a public administration to private partners in the project financing of those PPPs that face substantial market risks. In demonstrating this approach, the authors use the case of the Pedemontana Lombarda toll road, a major transportation infrastructure project in Northern Italy for which financial plans have been filed and whose start is now pending. The main function of real options in this case is to capture the effects on value of the major market risk in such projects—namely, the uncertainty about volume of traffic on the new road. The authors interpret the final indemnification price as the value of a real put option sold by the awarding authority to private investors (in the case of a project that would otherwise be unprofitable and have a negative NPV). The put option takes the form of a clause in the concession contract that gives investors the right, under certain circumstances, to sell the toll road back to the government for a fixed sum (in this case, €2.9 billion). According to the authors, this valuation approach is likely to be helpful in any kind of infrastructure project that faces risk stemming from the unpredictability of market demand and future revenue streams.     

Multidimensional principal–agent value for money in healthcare project financing

Value for money (VfM) is a key parameter for the public sector in the choice between a public–private partnership (PPP) and traditional procurement, especially for healthcare infrastructure. This paper investigates the differences in what VfM means to the public and private sectors.     

Risk Management in Public–Private Partnerships

This study investigates the risk management in long‐term concession contracts known as public–private partnerships (PPPs). The M4 is the first Australian PPP road concession to reach the end of its concession cycle. It provides a unique and timely opportunity to examine the risk management process over its contract term and the efficacy of PPP contractual structures in managing uncertainties. Our specific research interests focus on two questions. First, what risk management approach was implemented? Second, has the risk‐allocation strategy defined in the contract facilitated or hindered the risk management process? The findings of the study suggest that under the incomplete contract approach, the risk management practices rooted in a strong contractual framework, allied with good relationship skills, has contributed to a positive outcome for the M4 PPP. The study provides generalisable insights into risk management in inter‐organisational long‐term contracts.     

Risks and the financing of PPP: Perspectives from the financiers

Public private partnerships (PPP) are an established model for most governments internationally to provide infrastructure-based services, using private finance. Typically the public authority will sign a contract with a special purpose vehicle (SPV), which, because of the holistic nature of PPP, in turn sub-contracts the finance, design, construction, maintenance and soft services to companies that are often related to its shareholders. Thus there is a considerable network of linked organisations that together procure and provide the PPP project.While there is an increasing body of research that examines these PPP projects, much of it is interview or case study based so that the evidence is drawn from a small number of interviews or cases in specific sectors. It also focuses on the public sector procurer and the private sector contractor in the network of organisations. Although it has been recognised that the perceptions of the financiers may vary from those of other key PPP players there is much less research that focuses on the financiers.In this paper we report the results of a postal questionnaire survey, administered to 109 providers of senior debt and equity, from which the response rate was just less than 40%. We supplement these findings with a small number of illustrative quotes from interviewees, where the cited quote represents a commonly held view. We used SPSS and Nvivo to analyse the data.The findings show that when assessing PPPs financiers perceive a very wide range of risks as important, and that it is important to them that many of these risks are either insured or allocated to sub-contractors. When considering participating in PPPs, financiers agree that working with familiar partners on familiar projects and in familiar sectors is important, which may raise barriers to entry and undermine competitive processes.     

Infrastructure Public-Private Partnerships Re-Defined: An Increased Emphasis on “Partnerships”

A public-private partnership, also known as a “P3,” is usually structured as a long-term lease of a municipal asset (such as a toll road, port, or airport) by a private investor (and/or operator). Five years ago, P3s were viewed by municipalities primarily as a means for raising capital, and maximizing the upfront proceeds was often viewed as the primary goal. Today's transactions are now being redefined with the goal of developing sustainable long-term partnerships between the public and private sectors. Governments are increasingly intent on realizing efficiencies by partnering with the private sector to achieve improved services and accelerate needed capital improvements. As a result of this redefining, the P3 has become an essential tool in governments' financial arsenal to manage the many challenges facing municipalities, including budget deficits, large pension obligations, and extensive infrastructure funding needs.     

The impact of contract characteristics on the performance of public–private partnerships (PPPs)

Four significant features of public–private partnership (PPP) contracts are analysed to understand their impact on performance. These are whether the contract allows sanctions to be imposed; its complexity; its flexibility; and whether renegotiation is possible. The effects of these characteristics were investigated by surveying participants in all of the PPP projects in The Netherlands. The only feature considered to have any significant impact on perceived performance was the possibility of imposing sanctions. The authors’ findings cast doubt on earlier research into managing PPP performance and suggest that researchers, governments and the private sector need to look beyond contract terms to properly understand and manage PPP performance.     

Infrastructure Public‐Private Partnerships: “Partnerships” Come to Fruition

P3s are generally structured as long‐term leases of municipal assets like toll roads, ports, and airports by private investors/operators. Five years ago, municipalities viewed such partnerships primarily as a means of raising capital, and they often viewed maximizing the up‐front proceeds as the primary goal of the transactions. Today's P3s have been re‐defined to focus beyond the bottom line and toward the goal of developing sustainable long‐term partnerships between the public and private sectors. As three transactions from the past year are used to demonstrate, the P3 has emerged as a way for governments to achieve sustainable reinvestment in needed infrastructure while also using the best practices of the private sector to increase the efficiency of and revenue from their asset operations.     

Risk, PPPs AND THE Public Sector Comparator

This paper argues that the "first generation" approaches to private investment in public infrastructure in the United Kingdom and Australia were inappropriate and socially costly. In most cases, the PPP approach involves an inappropriate allocation of risk between the public and private sectors, an excessive cost of capital, and an inappropriate bundling of risk through the use of a single private partner (or consortium) rather than separate contracting for separate project stages. Conditions under which a PPP approach is likely to be appropriate are considered. The main conclusion is that the PFI/PPP approach should be adopted only in special cases.     

When does a public–private partnership (PPP) lead to inefficient cost management? Evidence from South Korea’s urban rail system

This paper investigates the impact of a public–private partnership (PPP) on the operational cost-efficiency of South Korea’s urban rail system. Seoul’s line 9, which is operated by a PPP, was compared with Seoul Metropolitan Rapid Transit (SMRT) which is entirely run by the public sector. Overall, no evidence was found that private operation led to clear and significant declines in costs to the public. Private shareholders, on the other hand, experienced a surprisingly high rate of return. The author explains why two characteristics defining a typical PPP—activity bundling and public–private risk-sharing—were behind this unintended outcome and makes suggestions to prevent other governments experiencing similar problems.     

Unbundling tolls from contracts: a new road PPP model

Considerable evidence from different countries has revealed important shortcomings in most road public–private partnership (PPP) models. In this paper a new PPP model is presented that overcomes some of the problems found in PPP road contracts. The new model is based on separating user tolls from the fees paid to PPP contractors and setting up new institutional arrangements to oversee PPPs.     

A Private-Sector Perspective

The Public-Private Partnership model is best placed as a means for delivering public infrastructure for government. However, the private sector needs to consider some issues if it is to encourage governments to use this model effectively. Specifically, for the public-private partnership model to be sustained and accepted by governments, the private sector needs to explain its benefits in a way that wins the trust of the community.     

Infrastructure public–private partnership project ecosystem – financial and economic positioning of stakeholders

The purpose of this paper is to construct an analytical cash flow-based project model to facilitate project appraisal of both private investors and public sector. With the help of the model that focuses on ecosystem and its stakeholders, it is simpler to identify potential conflicts usually encountered in public–private partnership (PPP) projects. The model construct is based on classical cash flow accounting and cost–benefit analysis. In the model, the flows of cash (private investors) and the flows of costs and benefits (public investors) are integrated in a single framework. The model shows that within the ecosystem the investors' (public vs. private) social, economic and financial targets are not necessarily coinciding. Prospecting of common ground and win–win situations becomes a crucial success factor for any PPP project. The paper discusses the policy and investment strategy implications for successful PPPs.     

Innovation in public–private partnerships (PPPs): the Spanish case of highway concessions

This article identifies the factors that determine innovation in transport PPPs in Spain. Innovation is an important way of achieving efficiency but it is not an intrinsic characteristic of PPP projects. The authors describe the multiple regression model they devised to estimate innovation. The results show that PPP contracts can be designed to maximize innovation in R&D. However, there does not appear to be greater innovation in any other areas. The information provided has important implications for public service organizations considering new contracts with the private sector.     

Institutional quality,investment efficiency,and the choice of public–private partnerships

We examine a sample of 625 public–private partnership (PPP) firms from 1980 to 2015 that straddle nine countries with varying degrees of economic development and PPP markets. We find that the motivations of the firms that undertake PPP investments vary. While private sector firms in economies with low institutional quality choose to engage in PPPs to alleviate capital constraints attributed to underinvestment, those in economies with high institutional quality participate in PPPs to solve the problem of overinvestment due to an abundant cash flow. In the long run, the benefits of lower capital constraints through PPP investments are more pronounced in economies with high institutional quality.     

New development: New global health care PPP developments—a critique of the success story

Health care public–private partnerships (PPPs), where clinical services as well as infrastructure are delivered by the private sector, are coming under the spotlight as governments seek to achieve value for money in health budgets. Existing examples have been widely reported as successful. However, this article urges caution as a closer look at the evidence shows that handing over control of service delivery to the private sector is difficult to monitor and evaluate, carries cost implications which remain largely unquantified and can create additional risk.     

Spanish healthcare public private partnerships: The ‘Alzira model’

Global infrastructure reports suggest that, in the wake of the fiscal crisis, healthcare PPPs are seen as a growing area as governments switch attention to social welfare projects. Spain is unique in having had a PPP hospital in operation for over a decade which is funded through a capitation fee. This paper takes a critical approach to evaluate this project, with our analysis showing that the original project could never have been viable and that the renegotiation of the contract has been costly to the government. Viewing the contract through a financialised lens we can see how this contract has been used to ‘make up’ a market for the private delivery of public healthcare in Spain. We also call into question the role of the Spanish savings banks in financing this type of project, which has now been replicated with further hospitals in Spain and Portugal, as well as in developing countries such as Lesotho.     

The valuation of risk transfer in UK school public private partnership contracts

A number of studies have examined the public private partnership (PPP) policy and have questioned the risk transfer argument used by the UK government to legitimise its adoption. This paper contributes to the literature by illustrating how accounting numbers have been used to value risks and justify the PPP decision. Data from the full business cases of two UK PPP schools and semi-structured interviews are used to illustrate the complexities and subjective judgements involved in valuing risks and achieving optimal risk transfer. The analysis suggests that the accounting numbers used to value risks are not neutral or objective but are socially constructed and may be manipulated to justify the PPP decision.     

Absence Management in the Public Sector: An Integrative Model?

Workforce absence rates in Britain have been found to be higher in the public sector than the private. The Government has set ambitious targets for the reduction of public sector absence rates and published a range of recommendations. The authors look at the ways the two sectors manage long-term absence. Although many public sector organizations, as well as some large private services ones, have systems in place, this article shows that these often contain structural weaknesses, and frequently do not operate in an integrated way. It is therefore concluded that many public organizations have some way to go to achieve the holistic approach to absence management advocated by the Government.     

Contracts,governance, and country risk in project finance: Theory and evidence

Project finance links financial structure to the operational characteristics of the project to optimize the allocations of various project risks. We develop a model in which concession grants and offtake agreements benefit both public and private sponsors in the presence of political risk. The public can use these contracts to incentivize the private sponsor to undertake an otherwise unacceptable project while benefiting from delegating the process of financing, building, and operating the project to the private sponsor. For the private sponsor, the government concession grant, while improving financial returns, entails political influence. We develop hypotheses connecting these contract choices to the public–private partnership governance structure of project finance and provide supporting evidence. Our findings suggest that a country's political and financial risks have significant impacts on the contract choice as well as the public–private governance structure in project finance. Projects in greater political risk countries tend to be structured with less government involvement in order to avoid political influence of the local government. Projects with the private finance initiative end up with more government involvement and control in order to protect the public interest.