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Default and Renegotiation in PPP Auctions

The winners of auctions for PPP contracts, especially for major infrastructure projects such as highways, often enter financial distress, requiring the concession to either be re-allocated or re-negotiated. We build a simple model to identify the causes and consequences of such problems. In the model, firms bid toll charges for a fixed-term high- way concession, with the lowest bid winning the auction. The winner builds and operates the highway for the fixed concession period. Each bidder has a privately known construction cost and there is common uncertainty regarding the level of demand that will result for the com- pleted highway. Because it is costly for the Government to re-assign the concession, it is exposed to a hold-up problem, which bidders can exploit through the strategic use of debt. Each firm chooses its finan- cial structure to provide optimal insurance against downside demand risk: the credible threat of default is used to extort an additional transfer payment from the Government. We derive the optimal finan- cial structure and equilibrium bidding behaviour and show that (i) the auction remains efficient, but (ii) bids are lower than they would be if all bidders were cash financed, and (iii) the more efficient the winning firm, the more likely it is to require a Government bail-out.

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File URL: http://www.uq.edu.au/economics/abstract/484.pdf
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Paper provided by School of Economics, University of Queensland, Australia in its series Discussion Papers Series with number 484.

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Date of creation: 20 Aug 2013
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Handle: RePEc:qld:uq2004:484
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  1. Bajari, Patrick & Tadelis, Steven, 2001. "Incentives versus Transaction Costs: A Theory of Procurement Contracts," RAND Journal of Economics, The RAND Corporation, vol. 32(3), pages 387-407, Autumn.
  2. Eduardo Engel & Ronald Fischer & Alexander Galetovic, 2007. "The Basic Public Finance of Public-Private Partnerships," Cowles Foundation Discussion Papers 1618, Cowles Foundation for Research in Economics, Yale University, revised Jan 2011.
  3. Zheng, Charles Z., 2001. "High Bids and Broke Winners," Journal of Economic Theory, Elsevier, vol. 100(1), pages 129-171, September.
  4. Eduardo M. R. A. Engel & Ronald D. Fischer & Alexander Galetovic, 2001. "Least-Present-Value-of-Revenue Auctions and Highway Franchising," Journal of Political Economy, University of Chicago Press, vol. 109(5), pages 993-1020, October.
  5. 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.
  6. Matthew Rhodes-Kropf & S. Viswanathan, 2005. "Financing Auction Bids," RAND Journal of Economics, The RAND Corporation, vol. 36(4), pages 789-815, Winter.
  7. Scott E. Masten & Stéphane Saussier, 2000. "Econometrics of Contracts : an Assessment of Developments in the Empirical Literature on Contracting," Revue d'Économie Industrielle, Programme National Persée, vol. 92(1), pages 215-236.
  8. Guasch, J. Luis & Laffont, Jean-Jacques & Straub, Stéphane, 2008. "Renegotiation of concession contracts in Latin America: Evidence from the water and transport sectors," International Journal of Industrial Organization, Elsevier, vol. 26(2), pages 421-442, March.
  9. Simon Board, 2007. "Bidding into the Red: A Model of Post-Auction Bankruptcy," Journal of Finance, American Finance Association, vol. 62(6), pages 2695-2723, December.
  10. Martimort, David & Pouyet, Jerome, 2008. "To build or not to build: Normative and positive theories of public-private partnerships," International Journal of Industrial Organization, Elsevier, vol. 26(2), pages 393-411, March.
  11. Robert G. Hansen, 1988. "Auctions with Endogenous Quantity," RAND Journal of Economics, The RAND Corporation, vol. 19(1), pages 44-58, Spring.
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