Risk shifting and long-term contracts : evidence from the Ras Gas Project
Risk shifting and incomplete contracting lie at the heart of the agency relationship inherent in the procurement and financing of large-scale projects such as power plants, oil and gas pipelines, and liquefied natural gas (LNG) facilities. Resolving this agency problem is critical in structuring the nexus of long-term contracts--construction, operating, output sale, and financial contracts--commensurate with the project's underlying tehcnological and market organization. By investigating the Ras Gas bonds--the largest and most liquid global project bonds ever issued in an emerging market economy--the authors provide empirical evidence of the risk-shifting consequences of contractual incompleteness. They relate the credit spreads of Ras Gas bonds to the bond spreads of the Korea Electric Power Company (Kepco), the major customer, in the context of a 25-year supply agreement, the oil price index used to price the LNG, emerging debt market returns, and various systematic and unsystematic risk variables. Consistent with theoretical predictions, they find that the risk factors affecting the sales and purchase agreements drive perceptions of market risk for Ras Gas bonds. In particular, Ras Gas yield spreads reflect the market's risk assessment of Kepco. Other priced risks are energy price and foreign currency exposure (which influence Ras Gas credit spreads through their impact on Kepco), Korean economic variables, and spillovers from turbulence in European and Latin American emerging debt markets. The authors'analysis shows that the design of each contractual arrangement is not independent, because risk factors relevant to one contract determine the price and risk premium of the other. Despite heavy capitalization and partial guarantees by the parent companies of Ras Gas, the off-take agreement essentially determines the riskiness of the bonds. The authors interpret this as evidence of the nexus-of-contracts view of the firm in the presence of contractual incompleteness: Investors bear all residual risks and price their financial claims accordingly.
|Date of creation:||30 Nov 2000|
|Date of revision:|
|Contact details of provider:|| Postal: 1818 H Street, N.W., Washington, DC 20433|
Phone: (202) 477-1234
Web page: http://www.worldbank.org/
More information through EDIRC
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Smith, Clifford Jr. & Warner, Jerold B., 1979. "On financial contracting : An analysis of bond covenants," Journal of Financial Economics, Elsevier, vol. 7(2), pages 117-161, June.
- Joskow, Paul L, 1987. "Contract Duration and Relationship-Specific Investments: Empirical Evidence from Coal Markets," American Economic Review, American Economic Association, vol. 77(1), pages 168-85, March.
- Georg Noldeke & Klaus M. Schmidt, 1995.
"Option Contracts and Renegotiation: A Solution to the Hold-Up Problem,"
RAND Journal of Economics,
The RAND Corporation, vol. 26(2), pages 163-179, Summer.
- Georg Nöldeke & Klaus M. Schmidt, 1992. "Option Contracts and Renegotiation - A Solution to the Hold-Up Problem," Discussion Paper Serie A 417, University of Bonn, Germany, revised Aug 1993.
- Nöldeke, Georg & Schmidt, Klaus M., 1995. "Option contracts and renegotiation: A solution to the Hold-Up Problem," Munich Reprints in Economics 19329, University of Munich, Department of Economics.
- Berkovitch, Elazar & Kim, E Han, 1990. " Financial Contracting and Leverage Induced Over- and Under-Investment Incentives," Journal of Finance, American Finance Association, vol. 45(3), pages 765-94, July.
- Joskow, Paul L, 1988. "Asset Specificity and the Structure of Vertical Relationships: Empirical Evidence," Journal of Law, Economics and Organization, Oxford University Press, vol. 4(1), pages 95-117, Spring.
- Jensen, Michael C. & Meckling, William H., 1976. "Theory of the firm: Managerial behavior, agency costs and ownership structure," Journal of Financial Economics, Elsevier, vol. 3(4), pages 305-360, October.
- John, Kose, 1987. " Risk-Shifting Incentives and Signalling through Corporate Capital Structure," Journal of Finance, American Finance Association, vol. 42(3), pages 623-41, July.
- Mathias Dewatripont & Philippe Aghion & Patrick Rey, 1994.
"Renegotiation design with unverifiable information,"
ULB Institutional Repository
2013/9591, ULB -- Universite Libre de Bruxelles.
- Aghion, Philippe & Dewatripont, Mathias & Rey, Patrick, 1994. "Renegotiation Design with Unverifiable Information," Econometrica, Econometric Society, vol. 62(2), pages 257-82, March.
- Aghion, Philippe & Dewatripont, Mathias & Rey, Patrick, 1994. "Renegotiation Design with Unverifiable Information," Scholarly Articles 12375014, Harvard University Department of Economics.
- Dailami, Mansoor & Leipziger, Danny, 1997.
"Infrastructure project finance and capital flows : a new perspective,"
Policy Research Working Paper Series
1861, The World Bank.
- Dailami, Mansoor & Leipziger, Danny, 1998. "Infrastructure Project Finance and Capital Flows: A New Perspective," World Development, Elsevier, vol. 26(7), pages 1283-1298, July.
- Kahan, Marcel & Yermack, David, 1998.
"Investment Opportunities and the Design of Debt Securities,"
Journal of Law, Economics and Organization,
Oxford University Press, vol. 14(1), pages 136-51, April.
- Marcel Kahan & David Yermack, 1996. "Investment Opportunities and the Design of Debt Securities," New York University, Leonard N. Stern School Finance Department Working Paper Seires 96-31, New York University, Leonard N. Stern School of Business-.
- Joskow, Paul L, 1988.
"Price Adjustment in Long-term Contracts: The Case of Coal,"
Journal of Law and Economics,
University of Chicago Press, vol. 31(1), pages 47-83, April.
- Paul L. Joskow, 1987. "Price Adjustment in Long Term Contracts: The Case of Coal," Working papers 444, Massachusetts Institute of Technology (MIT), Department of Economics.
- Klein, Benjamin & Crawford, Robert G & Alchian, Armen A, 1978. "Vertical Integration, Appropriable Rents, and the Competitive Contracting Process," Journal of Law and Economics, University of Chicago Press, vol. 21(2), pages 297-326, October.
- John, Kose & John, Teresa A. & Senbet, Lemma W., 1991. "Risk-shifting incentives of depository institutions: A new perspective on federal deposit insurance reform," Journal of Banking & Finance, Elsevier, vol. 15(4-5), pages 895-915, September.
- Longstaff, Francis A & Schwartz, Eduardo S, 1995. " A Simple Approach to Valuing Risky Fixed and Floating Rate Debt," Journal of Finance, American Finance Association, vol. 50(3), pages 789-819, July.
- Schwartz, Alan, 1997.
"Contracting about Bankruptcy,"
Journal of Law, Economics and Organization,
Oxford University Press, vol. 13(1), pages 127-46, April.
- Harris, Milton & Raviv, Artur, 1985. " A Sequential Signalling Model of Convertible Debt Call Policy," Journal of Finance, American Finance Association, vol. 40(5), pages 1263-81, December.
When requesting a correction, please mention this item's handle: RePEc:wbk:wbrwps:2469. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Roula I. Yazigi)
If references are entirely missing, you can add them using this form.