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Avoiding customer and taxpayer bailouts in private infrastructure projects : Policy toward leverage, risk allocation, and bankruptcy

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  • Ehrhardt, David
  • Irwin Timothy
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    Abstract

    Many private infrastructure projects mix regulation that subjects the private company to considerable risk, a government or regulator that is reluctant to see the company go bankrupt, and high leverage on the part of the company. If all goes well, equityholders make a profit, debtholders are repaid, customers pay no more than they expected, and the government is not called on to bail the company out. If all goes badly enough, however, the prospect of bankruptcy will loom. Unwilling to see the company go bankrupt, however, the regulator will have to permit an unscheduled price increase, or the government will have to inject taxpayers'money into the firm. In other words, the combination means customers and taxpayers bear more risk than would appear from the regulations governing the private infrastructure project. The authors examine how these problems have played out in five cases. Then they describe how governments and regulators can quantify the extent of the problems and, using option-pricing techniques, value the customer and taxpayer guarantees involved. Finally, the authors analyze three options for mitigating the problem: making bankruptcy a more credible threat, limiting the private operator's leverage, and reducing the private operator's exposure to risk. The authors conclude that appropriate policy depends on the tax system, the feasibility of enforcing bankruptcy, and the benefits of risk transfer from taxpayer to theprivate sector.

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    Bibliographic Info

    Paper provided by The World Bank in its series Policy Research Working Paper Series with number 3274.

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    Date of creation: 01 Apr 2004
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    Handle: RePEc:wbk:wbrwps:3274

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    Related research

    Keywords: International Terrorism&Counterterrorism; Payment Systems&Infrastructure; Public Sector Economics&Finance; Banks&Banking Reform; Economic Theory&Research; Banks&Banking Reform; Public Sector Economics&Finance; Environmental Economics&Policies; Economic Theory&Research; Municipal Financial Management;

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    1. Dasgupta, Sudipto & Nanda, Vikram, 1993. "Bargaining and brinkmanship : Capital structure choice by regulated firms," International Journal of Industrial Organization, Elsevier, vol. 11(4), pages 475-497.
    2. Hinojosa, Sergio & Gomez-Lobo, Andres, 2000. "Broad roads in a thin country - infrastructure concessions in Chile," Policy Research Working Paper Series 2279, The World Bank.
    3. Ivo Welch, 2002. "Columbus' Egg: The Real Determinant of Capital Structure," NBER Working Papers 8782, National Bureau of Economic Research, Inc.
    4. Yossef Spiegel & Daniel F. Spulber, 1994. "The Capital Structure of a Regulated Firm," RAND Journal of Economics, The RAND Corporation, vol. 25(3), pages 424-440, Autumn.
    5. Stewart C. Myers, 2001. "Capital Structure," Journal of Economic Perspectives, American Economic Association, vol. 15(2), pages 81-102, Spring.
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    Cited by:
    1. Etienne B. Yehoue & Mona Hammami & Jean-François Ruhashyankiko, 2006. "Determinants of Public-Private Partnerships in Infrastructure," IMF Working Papers 06/99, International Monetary Fund.
    2. World Bank, 2006. "Approaches to Private Participation in Water Services : A Toolkit," World Bank Publications, The World Bank, number 6982, October.
    3. Mario, Cuevas, 2007. "A Practical Guide to the Assessment of the Vulnerability of the Non-Financial Private Sector," MPRA Paper 1375, University Library of Munich, Germany.
    4. Clive Harris & Sri Tadimalla Kumar, 2008. "Financing the Boom in Public-Private Partnerships in Indian Infrastructure : Trends and Policy Implications," World Bank Other Operational Studies 10577, The World Bank.

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