Contractual flexibility or rigidity for public private partnerships? Theory and evidence from infrastructure concession contracts

Athias, Laure and Saussier, Stéphane (2007): Contractual flexibility or rigidity for public private partnerships? Theory and evidence from infrastructure concession contracts.

Abstract

In this article, we explore the contractual design of toll infrastructure concession contracts. We highlight the fact that the contracting parties try to sign not only complete rigid contracts in order to avoid renegotiations but also flexible contracts in order to adapt contractual framework to unanticipated contingencies and to create incentives for cooperative behavior. This gives rise to multiple toll adjustment provisions and to a tradeoff between rigid and flexible contracts. Such tradeoff is formalized with an incomplete contract framework, including ex post maladaptation and renegotiation costs. Our model highlights the fact that trade-offs are complex and do not correspond to previous propositions coming from a transaction cost framework. More precisely, those previous works argue that a rigid contract is to be preferred as soon as specific assets are high. We highlight the fact that this proposition may be true, but only if other conditions concerning maladaptation costs, renegotiation costs and the probability to see the contract enforced are met. Furthermore, our results stress the fact that the institutional environment in which the contract is embedded matters. Propositions are tested using an original database of 71 concession contracts. Our results suggest an important role for economic efficiency concerns, as well as politics, in designing toll road concession contracts. In this perspective, our work complements other empirical studies on contractual price provisions (Masten-Crocker 1991, Crocker-Reynolds 1993, Bajari-Tadelis 2001, Bajari & al 2006), by considering the case of public-private contracting, as well as other studies on public-private partnerships, by focusing on toll adjustment provisions and documenting the effect of reputation and political ideology.

• Item Type: MPRA Paper
• Language: English
• Keywords: Contractual design; Incomplete contract theory; Transaction cost theory; price provisions; Public private partnerships
• Subjects: H - Public Economics > H5 - National Government Expenditures and Related Policies > H54 - Infrastructures ; Other Public Investment and Capital Stock; D - Microeconomics > D2 - Production and Organizations > D23 - Organizational Behavior ; Transaction Costs ; Property Rights; L - Industrial Organization > L1 - Market Structure, Firm Strategy, and Market Performance > L14 - Transactional Relationships ; Contracts and Reputation ; Networks; H - Public Economics > H1 - Structure and Scope of Government > H11 - Structure, Scope, and Performance of Government; L - Industrial Organization > L9 - Industry Studies: Transportation and Utilities > L90 - General; D - Microeconomics > D8 - Information, Knowledge, and Uncertainty > D82 - Asymmetric and Private Information ; Mechanism Design; L - Industrial Organization > L2 - Firm Objectives, Organization, and Behavior > L24 - Contracting Out ; Joint Ventures ; Technology Licensing

References

Athias L. and S. Saussier, [2007], “Un Partenariat Public Privé rigide ou flexible ? Théorie et application aux concessions routières à péage”, forthcoming in Revue Economique, May 2007.

Bajari P., Houghton, Tadelis S., [2006], “Bidding for Incomplete Contracts”, Working Paper.

Bajari P, McMillan R. and Tadelis S, [2003], “Auctions versus Negotiations in Procurement: An Empirical Analysis”, NBER Working Papers, 9757.

Bajari P, Tadelis S, [2001], “Incentives versus Transaction Costs: a Theory of Procurement Contracts”, Rand Journal of Economics, 32(3), 387-407.

Banerjee A.V., Duflo E., [2000], “Reputation Effects and the Limits of Contracting: A Study of the Indian Software Industry”, Quarterly Journal of Economics, 115(3), 989-1017.

Bennett J., Iossa E., [2005], “Contracting Out Public Service Provision to Not-For-Profit Firms”, CMPO Working Paper No. 05/124.

Cour des Comptes, [1998], "La politique autoroutière française", rapport de la Cour des Comptes, politique autoroutière -2-.

Crocker K.J., Masten S.E., [1991], "Pretia ex Machina?: Prices and Process in Long Term Contracts", Journal of Law and Economics, 34, 64 69.

Crocker K.J., Reynolds K.J., [1993], "The Efficiency of Incomplete Contracts: An Empirical Analysis of Air Force Engine Procurement", Rand Journal of Economics, 24, 126 146.

Doni N., [2005], “The Importance of Reputation In Awarding Public Contracts”, Working Paper.

Engel E., Fisher R., Galetovic A., [1997], “Highway Franchising: Pitfalls and Opportunities“, American Economic Review, 87, 68-72.

Engel E., Fischer R., Galetovic A., [2002], “A New Approach to Private Roads”, Regulation, Fall 2002, 18-22.

Engel E., Fisher R., Galetovic A., [2003], “Privatizing Highways in Latin America: Fixing What Went Wrong?”, Economia, The Journal of LACEA, 4, 129-158.

Engel E., Fisher R., Galetovic A., [2006], “Privatizing Highways in the United States”, Review of Industrial Organization, 29, 27-53.

Engel E., Fisher R., Galetovic A., [2006], “Renegotiation Without Holdup: Anticipating Spending and Infrastructure Concessions”, Working Paper.

Estache A., [2006], “PPI partnerships vs. PPI divorces in LDCs” Review of Industrial Organization, 29, 3-26.

Flyvberg B., Bruzelius N. and Rothengatter W., [2003], “Megaprojects and Risk – An Anatomy of Ambition”, Cambridge: Cambridge University Press, 207p.

Flyvbjerg B., Skamris M. and Buhl S.L., [2002], “Underestimating Costs in Public Works Projects: Error or Lie?”. Journal of the American Planning Association, 68, 279-95.

Flyvbjerg B. and Skamris M., [1997], “Inaccuracy of Traffic Forecasts and Cost Estimates on Large Transport Projects”, Transport Policy, 4(3), 141-6.

Goldberg V.P., [1985], “Price Adjustment in Long-Term Contracts”, Wisconsin Law Review, 527-543.

Goldberg V.P., Erickson J.E., [1987], "Quantity and Price Adjustment in Long Term Contracts: A Case Study of Petroleum Coke", Journal of Law and Economics, 30, 369 398.

Gomez-Ibanez J.A. and Meyer J. R., [1993], “Going Private: The International Experience with Transport Privatization”, The Brookings Institution, Washington, D.C.

Grout P. and Stevens M., [2003], “The Assessment: Financing and Managing Public Services”, Oxford Review of Economic Policy, 19, 215-234.

Guasch J.L., Laffont J.J., Straub S., [2006], “Renegotiation of Concession Contracts: A Theoretical Approach”, Review of Industrial Organization, 29, 55-73.

Guasch J. Luis, [2004], “Granting and Renegotiating Infrastructure Concessions: Doing it Right”, World Bank Institute.

Hart O.D., [1995], “Firms, Contracts, and Financial Structure”, Oxford and New York: Oxford University Press, Clarendon Press.

Hart O.D., [2003], “Incomplete Contract and Public Ownership: Remarks, and an Application to Public-Private Partnerships”, The Economic Journal, 113, 69-76.

Hart O. D. and Holmstrom, B., [1987], “The Theory of Contracts,” in Advances in Economic Theory, T.R. Bewley (ed.). Fifth World Congress. Cambridge: Cambridge University Press, 369-98.

HM Treasury, [2003], “PFI: meeting the investment challenge”, The Stationery Office, London, UK.

Holmstrom B. and Milgrom P., [1991], “Multitask Principal-Agent Analyses: Incentive Contracts, Asset Ownership, and Job Design”, Journal of Law, Economics, and Organization, 7, 24-52.

Jolls C., [1997], “Contracts as Bilateral Commitments: A New Perspective On Contract Modification”, Journal of Legal Studies, 26, 203-237.

Kaufmann D., Kraay A., Mastruzzi M., [2004], “Governance Matters III: Governance Indicators for 1996, 1998, 2000, and 2002”, World Bank Economic Review, 18, 253-287.

Klein, B. [1992], ”Contracts and Incentives” in L. Werin and H. Wijkander (eds.), Contract Economics. Cambridge, MA: Basil Blackwell, 149-172.

Laffont, J.J., [2005], “Regulation and Development”, Cambridge University Press, 292p.

Levin J., Tadelis S., [2005], “Contracting for Government Services: Theory and Evidence from U.S. Cities”, Working Paper.

Martimort D. and S. Straub [2006], “Privatization and Changes in Corruption Patterns: The Roots of Public Discontent”, Working Paper.

Masten S.E., Saussier S. [2002], ”Econometrics of Contracts : An Assessment of Developments in the Empirical Literature of Contracting”, in Economics of Contracts: Theories and Applications, Brousseau E. & Glachant J-M Eds, Cambridge University Press, 273-293.

Odeck, James, [2004], “Cost Overruns in Road construction – What Are their Sizes and Determinants?”, Transport Policy, 11 (1), 43-53.

Pickrell, D., [1990], “Urban Rail Transit Projects: Forecasts Versus Actual Ridership and Cost”. Washington, D.C.. Department of Transportation.

Prud’homme R., [2004], “Infrastructure and Development”, Annual Bank Conference on Development Economics, Washington, May 3-5, 2004.

PWC [2005], “Delivering the PPP promise”, Price Waterhouse Coopers Study.

Saussier S., [2000], “Transaction Costs and Contractual Completeness”, Journal of Economic Behavior and Organization, 42, 189-206.

Schmidt, K. [1996], “The Costs and Benefits of Privatization: An Incomplete Contract Approach”, Journal of Law, Economics and Organization, 12, 1-24.

Schugart C., [2005], “The Selection of Concessionaires In the Urban Water Sector: Does the Standard Procurement Paradigm Fit ?”, Working Paper.

Tirole J., [1999], “Incomplete Contracts: Where Do We Stand ?”, Econometrica, 67, 741-781.

Williamson O.E., [1976], “Franchise Bidding for Natural Monopolies – In General and with Respect to CATV”, Bell Journal of Economics, 7, 73-104.

Williamson O.E., [1985], “The Economic Institutions of Capitalism”, New-York Free Press.

Williamson O.E., [1996], “The Mechanisms of Governance”, Oxford University Press.