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Financing PPP Projects with PVR Contracts: Theory and Evidence from the UK and Chile

Author

Listed:
  • Eduardo Engel
  • Ronald Fischer
  • Alexander Galetovic
  • Jennifer Soto

Abstract

Risk allocation is an essential component of a successful public-private partnership contract financed with user fees. For many of these projects, demand risk is large and mostly exogenous. This suggests that we evaluate contract designs that do not force the concessionaire to bear risk it cannot manage. In this paper we study present-value-of-revenue (PVR) contracts, which have this property. Under a PVR contract, the regulator sets the discount rate and the tariff schedule and firms compete on the present value of tariff revenue. The lowest bid wins and the contract lasts until the winning firm collects revenue equal to its bid. We provide a theoretical analysis comparing debt financing under a fixed term concession and PVR. We show that, other things equal, debt is less risky under PVR, particularly against large systemic shocks, and therefore debt-to-capital ratios can be higher. In addition, we show that the view that PVR does not mesh easily with fixed maturity debt is wrong. The reason is that demand realizations are independent of contractual forms. Finally, we analyze the experience with PVR contracts, considering two early examples from the UK and close to thirty PVR contracts for highways and airports in Chile. We conclude that PVR contracts have been at least as attractive to lenders than their fixed term counterparts. We also provide evidence of better incentives under PVR, in particular, a significant reduction of contract renegotiations. JEL Codes: H44, R42. Key words: default risk,fixed term contract,flexible term contract,Infrastructure concession,prepayment risk,project finance.

Suggested Citation

  • Eduardo Engel & Ronald Fischer & Alexander Galetovic & Jennifer Soto, 2019. "Financing PPP Projects with PVR Contracts: Theory and Evidence from the UK and Chile," Documentos de Trabajo 347, Centro de Economía Aplicada, Universidad de Chile.
    • Handle: RePEc:edj:ceauch:347
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    References listed on IDEAS

    as
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    More about this item

    Keywords

    default risk; fixed term contract; flexible term contract; infrastructure concession; prepayment risk; project finance.;
    All these keywords.

    JEL classification:

    • H44 - Public Economics - - Publicly Provided Goods - - - Publicly Provided Goods: Mixed Markets
    • R42 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - Transportation Economics - - - Government and Private Investment Analysis; Road Maintenance; Transportation Planning

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