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.     

Modelling Risk Perceptions of Stakeholders in Public–Private Partnership Toll Road Contracts

This paper investigates the risk perceptions of key stakeholder groups typically involved in public–private partnership (PPP) toll roads. Risk perceptions have an important impact on these PPP schemes for investing in public infrastructure. However, the nature and extent of risk associated with the specification of a PPP contract that commits contracting parties to deliver on their obligations remain unclear. In the context of major transport infrastructure, such as a new toll road, the often‐cited key risk to investors is the traffic (and hence demand) risk. There are, however, other risks, including political risk and media risk, the latter often causing untold harm resulting in modifications to the planned infrastructure. This paper develops a method to capture evidence on how public sector and private sector partners involved in previous PPPs perceive the levels of risk associated with each risk attribute, as a way of identifying the ex ante risk setting brought to negotiations in PPP toll road investments. Using a sample of 101 experts with contract experience in 32 countries, we develop a stated choice experiment and estimate a discrete choice model to quantify a risk profile index (RPI) to capture the perceived (relative) influence of each dimension of risk, and then identify sources of systematic differences in the RPI as a way of understanding the influence of personal traits and contextual and contractual factors.     

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.     

Value Capture: A Valid Means of Funding PPPs?

This paper considers the use of value capture (VC) as a means of financing public‐private partnerships (PPPs) in the United Kingdom (UK). Although some VC techniques are used in the UK, they are employed more widely in the United States of America. After considering the traditional approach to financing UK PPPs, this paper describes the main VC finance instruments. The findings of a series of case studies are then presented and conclusions drawn. While VC financing may prove unpopular with those bearing the cost of infrastructure improvements, it is recommended that such instruments are considered by UK policy makers.     

Cost of capital and valuation in the public and private sectors: Tax,risk and debt capacity

Cost of capital and valuation differ in the private and public sectors, because taxes are a cost to the private sector but are only a transfer to the public sector. We show how to transform the after-tax private sector cost of capital into its pre-tax equivalent, for comparison with the public sector cost of capital. We establish the existence of a tax induced wedge between these two costs of capital. The wedge introduces a preference on the part of the private sector for assets with rapid tax depreciation, high debt capacity and low risk. We show that, in circumstances where an asset has identical public and private sector valuation in the absence of taxes, the tax induced difference in valuation is identical to the change in government tax receipts that results from having the asset owned by the private rather than the public sector. We provide some examples of distortions that result from failure to adjust for changes in tax revenues, and show how to effect such adjustment.     

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.     

Overcoming Opportunism in Public‐Private Project Finance

The possibility of opportunistic behavior, whether by the private investors who operate public‐private projects or by the government agencies who oversee and administer them, can become a powerful deterrent to raising public‐private project financing, especially considering the scale of the investment in infrastructure. Nevertheless, both parties can protect themselves against the counterparty's possible opportunism by giving the investor an “exit” (or put) option and the public agent a “bail‐out” (or call) option on the private investor's shares. In describing the role and design of such puts and calls, this paper presents a mechanism for converting “natural monopolies” into competitive or contestable markets by using over‐the‐counter option contracts that combine the stability of long‐term contracts and the flexibility of short‐term contracts. In the language of economists, the exit/bail‐out option mechanisms presented here are seen as reducing barriers to entry by streamlining incomplete long‐term contracts and avoiding contractual problems related to “bounded rationality” and opportunism.     

政府补贴和国有参股对参与PPP企业外部融资的影响

政府补贴和国有资本参股是政府参与PPP(政府和社会资本合作)的两种主要方式。本文借助一个资本具有外部性的一般均衡模型来分析这两种方式对企业外部融资的影响机制,并进行经验验证。理论分析发现,国有参股的担保效应增加了项目公司对高杠杆的需求,提升了金融中介发放贷款的意愿,使金融中介接受更低的借款利率。政府补贴不影响项目公司与金融中介之间的借贷合约。项目公司外部融资所受影响会进一步传导至参与PPP的企业。因此,国有参股增加稳态时的企业杠杆率,降低借款利率;政府补贴则不影响杠杆率和利率。实证部分通过整合2014-2018年财政部PPP项目库数据和2010-2018年上市公司财务数据,借助PSM-DID分析发现,国有参股程度显著降低参与PPP项目的上市公司的借贷成本并提升其杠杆率,但政府补贴支出没有明显作用,印证了模型结论。此外,市场化程度更高的地区,国有参股程度对参与企业外部融资的影响程度更小。本文研究对PPP模式下如何减少政府债务风险以及控制债务风险向企业转移具有一定的参考意义。     

USING PROJECT FINANCE TO FUND INFRASTRUCTURE INVESTMENTS

For much of the past century, there has been an increased tendency for large infrastructure projects to be funded and operated by governments. Since the early 1980s, however, private-sector financing and management of such projects have experienced a dramatic revival. In some cases, this revival has taken the form of the "privatization" of an entire industry. But another, increasingly common, form has been the use of project finance to fund instrastructure investments. Besides being widely used in infrastructure investments like telecommunications and power generation in developing countries, the use of project finance has recently been extended by the U.K.'s Private Finance Initiative to fund public enterprises as diverse as the construction and operation of prisons, hospitals, subway cars, and the National Insurance computer system.
In a project financing, the project is managed by a separate company that is owned by a project sponsor (or sponsors) who usually takes an active role in the management of the project. The project company enters into a complex series of contracts with multiple parties, including the host government, the project's customers and suppliers, and the banks that typically provide most of the debt financing.
This paper argues that the equity investment by the project's operators works together with high debt ratios and the web of contractual arrangements to reduce "agency" problems in the management of large projects. It also shows how the contracts shift the various project risks to those parties best able to appraise and control them. Finally, it discusses why most project financing takes the form of limited recourse bank loans to the project company rather than, say, public bonds with full recourse to the sponsors.     

How Banks Price Loans to Public‐Private Partnerships: Evidence from the European Markets

This article presents the findings of a recent analysis of the drivers of credit spreads in project finance loans to public‐private partnerships, or PPPs, an increasingly popular form of procurement worldwide. PPPs are project finance transactions in which project output is a function of government policy in fields such as health, transport, and education. Because of the controversy that now surrounds the use of private finance in PPPs, understanding the determinants of the cost of debt in such highly leveraged projects is of interest to policy makers as well as originators and participants in the transactions. Using a large sample of credit spreads on debt extended to PPP projects in Europe over the past 15 years, the authors' study reports that market risk is the only significant driver of PPP debt credit spreads in a large portfolio of PPP debt; at the same time, technical risks appear to be diversified “away” by the structuring of the projects. Most important, and contrary to standard debt pricing models, factors like loan size, maturity, and leverage do not show up as significant determinants of the cost of debt in PPPs, reflecting a high degree of confidence by lenders that loans will be repaid or recovered. These results support the view that the use of project finance in PPPs is premised on effective risk management as well as confidence in the private sector's ability to manage public projects.     

Public-Private Partnerships: Form Over Substance?

Public-private partnerships have been devised to avoid treating financing arrangements as government "debt". Governments face incentives to avoid treating these arrangements as giving rise to liabilities. Both the Australian and UK standards boards have avoided a "substance over form" approach in order to accept that PPPs may be kept off-balance-sheet. The analysis supporting their conclusions was based on consideration of whether PPPs led to the acquisition of an asset, using the analogy of accounting for finance leases, rather than addressing whether the substance of commercial arrangements means that contractual commitments may evolve into liabilities.     

Public‐Private Partnerships: Form Over Substance?

Public-private partnerships have been devised to avoid treating financing arrangements as government "debt". Governments face incentives to avoid treating these arrangements as giving rise to liabilities. Both the Australian and UK standards boards have avoided a "substance over form" approach in order to accept that PPPs may be kept off-balance-sheet. The analysis supporting their conclusions was based on consideration of whether PPPs led to the acquisition of an asset, using the analogy of accounting for finance leases, rather than addressing whether the substance of commercial arrangements means that contractual commitments may evolve into liabilities.     

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.     

BEYOND RATE OF RETURN: REORIENTING PROJECT APPRAISAL

Traditional approaches to project appraisal fail in practiceto address two fundamental questions: whether a project belongsin the public or the private sector; and what effect any externalassistance associated with the project has on the country'sdevelopment. The first issue is of general interest to bothnational policymakers and international donors. If the governmentprovides a good or service that would otherwise have been providedby the private sector, the net contribution of the public projectcould be low. The second issue is of particular concern to donors.If financial resources are fungible, the project being appraisedmight well have been undertaken with out external financing.In this case, donor funds are actually financing some other,unappraised project. Both cases argue for a shift in the emphasisof project evaluation away from a concern with precise rate-of-returncalculations and toward broader sectoral analyses and publicexpenditure reviews. In this context, three areas critical forproper project appraisal include a consideration of the rationalefor public intervention, the fiscal impact of the project, andthe fungibility of external assistance.      

Development of PPPs IN Victoria

Governments around Australia and internationally have come to recognise that both public and private sectors have roles to play in building modern public infrastructure. Governments are increasingly turning to mechanisms known as public-private partnerships (PPPs) or the private finance initiative (PFI).₁ The nature of PPPs and the reasons governments use them have evolved over the past 20 years and are continuing to do so. This article describes the evolution of PPPs in Victoria since the late 1980s, the accounting treatment of PPPs and future developments.     

Learning through Partnership: Private Finance and Managementin the Delivery of Services for London

This article looks at the attractiveness of the Private Finance Initiative (PFI) and Public-Private Partnerships (PPPs) to the private sector. One of the authors works for Jarvis plc—the company has been a major participant in PFI projects and, more recently, in various PPPs in London and across the UK. The article aims to identify a realistic model of the role of the private sector in PPPs. The authors use three case studies from London to recommend ways of improving the partnership element of PPPs in order to reach a 'win-win' situation, rather than the traditional adversarial approach between private and public sectors.     

Has the Public Sector Retained its 'Model Employer' Status?

The authors investigate whether public sector organizations can still be considered 'model employers' as they were before the late 1970s. Comparisons are made with private sector human resource management (HRM) practices to determine how closely the 'model employer' rhetoric approximates the public sector reality. The article focuses on recent changes in the core and traditional non-traded areas of public sector employment funded directly through either central or local taxation—the National Health Service, central and local government and higher education. Objective quantitative data on public sector HRM practices and flexible work patterns are examined from both primary and secondary sources. Central to the discussion is the question of which sector offers the greater job security to employees.     

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.     

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.     

Rethinking the relationship between local government and financial markets

In the past 20 years local governments have increasingly looked to financial markets for capital financing. The markets want local governments to change their accounting systems and become more transparent, in order to offer information that is more appropriate to private sector investors. The authors argue that this approach is only a partial solution, and that local government and financial institutions would both benefit from changes in their relationships. The article identifies a double knowledge gap that needs to be filled if the public and private sectors want to work together as long-term financial partners.