Risk Allocation and the Costs and Benefits of Public-Private Partnerships

We study the agency costs of delegated public service provision, focusing on the link between organizational forms and uncertainty at project implementation. We consider a dynamic multitask moral hazard environment where the mapping between effort and performance is ex ante uncertain but new information may come along during operations. Our analysis points out at the efficiency gains that bundling planning and implementation - as under Public Private Partnerships - can bring in terms of better project design and lower operational costs. Bundling also results in increasingly better performance as uncertainty is reduced by growing experience in the sector. Bundling should instead be viewed with caution when the private sector seeks to radically innovate on public service provision or to introduce new services but lacks the knowledge and expertise to anticipate the impact of the innovative design/procedure/technology on the cost of operations. The compounding of asymmetric information ex post plus moral hazard and renegotiation may generate diseconomies of scope in agency costs which, for high operational risk, can make unbundling optimal. In this context, the use of private finance can help re-establishing the benefit of bundling only if lenders have sufficient expertise to help assessing project risks.