The realization of most public projects requires two main sequential stages: the planning stage where the project is designed, and the implementation stage where the project is executed. Under a public-private partnership (hereafter abbreviated as PPP), the supplier takes responsibility for both the building of the infrastructure and its managing and maintenance. The DBFO model (‘Design’, ‘Build’ ‘Finance’ and ‘Operate’), the BOT model (‘Build’, ‘Operate’ and ‘Transfer’) or the BOO (‘Build’, ‘Own’ and ‘Operate’) are all common contractual modes that feature bundling of building and operation in a single contract with a single firm (or consortium of firms).
PPPs are used across Europe, Canada, the U.S. and a number of developing countries for the provision of public infrastructures and services in sectors such as transport, energy, water, IT, prisons, waste management, schools, hospitals and others. Transport projects for toll roads, ports and rail typically follow the ‘concession model’, where the private provider recoups (part or all of) its initial investment through charges to final users. In PPP hospitals, schools and prisons, instead, where users typically do not pay; it is the public sector that pays the private sector party for the service that it provides to users. This is known as the ‘PFI model’.
When principals delegate to agents the tasks of planning and implementing projects, both moral hazard and adverse selection problems may arise. At planning stage, the agent may have to be motivated to efficiently design the project. At implementation stage, the agent may have to be motivated to exert effort in managing the project and to use efficiently the information that comes along during operations. In this paper, we study how uncertainty at implementation stage affects the design of compensation schemes for the agents, and we derive implications for the optimality of PPP agreements. Uncertainty is important not just because the agent maybe risk averse but also because it affects the degree of contract incompleteness.
Consider the changes that we have witnessed in the last twenty years to the way public services are provided. A central theme in both developed and developing countries has been an increasing level of delegation to the private sector for the provision of public services. Not only have traditional services such as transport, energy and gas been increasingly privatized, but new or more complex services have been contracted out for which there is no precedent in the private sector. Europe for example is experiencing with the delegation of prisons operations, of school design and maintenance, of new methods for waste disposal such as recycling plants, and with an increasingly use of transport concessions for toll roads, rail, ports and bridges.
When the UK Government first outsourced the electronic monitoring services for the Home Detention Curgew (HDC) scheme in the mid 1990s the service was so new that there was no precedent for the service model (Serco Institute 2007). When the UK National Audit Office (NAO) reviewed the success of the three highly complex PPP deals to finance and manage London’s Underground system, two years after the first contract was signed, and in spite of a period of ’shadow running’ to review arrangements and make adjustments, they found it “hard to determine whether [the measures were] easy or difficult to achieve, and whether they [were] sufficiently aggressive” (NAO, 2004).
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Risk Allocation and the Costs and Benefits of Public-Private Partnerships
