Optimal Contracts, Capital Structure, and Infrastructure Project Financing
67 Pages Posted: 17 Jun 2016 Last revised: 23 Dec 2019
Date Written: December 1, 2017
We theoretically analyze the optimal contracts and the capital structure of public-private partnerships (PPPs) formed to implement infrastructure projects under a limited-recourse project financing arrangement. In our model, a sponsoring company and a host government set up a project company in order to build up a project and to operate it in the long run. The project has two phases: a build-up phase and an operating phase, with contracting between parties occurring before build-up. The sponsoring company and the government each contribute part of the project investment in return for equity stakes in the project company. The remaining investment for project build-up is provided as a limited-recourse loan by a banking consortium. Both the sponsoring company and the government need to provide non-contractible inputs into the project during the build-up phase at a private cost to themselves: these input costs are unknown prior to contracting and are realized only during project build-up. The probability of project success is increasing in the level of inputs provided by each party. We solve for the optimal capital structure (debt versus equity) of the project company; the optimal equity stakes held by each party in the project company; and the interest rate charged. We also solve for the optimal choice between the build-operate-own (BOO) and build-operate-transfer (BOT) provisions in contracts for the long-run ownership and operation of the project, and provide a rationale for the inclusion of performance guarantees in such contracts.
Keywords: Infrastructure finance, Capital structure, Ownership structure, Build-operate-transfer, Build-operate-own, Performance guarantees, Limited-recourse project financing.
JEL Classification: G31, G32, G21, M41
Suggested Citation: Suggested Citation