COWLES FOUNDATION FOR RESEARCH IN ECONOMICS
AT YALE UNIVERSITY

Box 208281
New Haven, CT 06520-8281

COWLES FOUNDATION DISCUSSION PAPER NO. 1723

Soft Budgets and Renegotiations in Public-Private Partnerships

Eduardo Engel, Ronald Fischer and Alexander Galetovic

August 2009

Public-private partnerships (PPPs) are increasingly used to provide infrastructure services. Even though PPPs have the potential to increase efficiency and improve resource allocation, contract renegotiations have been pervasive.

We show that existing accounting standards allow governments to renegotiate PPP contracts and elude spending limits. Our model of renegotiations leads to observable predictions: (i) in a competitive market, firms lowball their offers, expecting to break even through renegotiation, (ii) renegotiations compensate lowballing and pay for additional expenditure, (iii) governments use renegotiation to increase spending and shift the burden of payments to future administrations, and (iv) there are significant renegotiations in the early stages of the contract, e.g. during construction. We use data on Chilean renegotiations of PPP contracts to examine these predictions and find that the evidence is consistent with the predictions of our model. Finally, we show that if PPP investments are counted as current government spending, the incentives to renegotiate contracts to increase spending disappear.

Keywords: Build-operate-and-transfer, Concessions, Lowballing

JEL Classification: H21, L51, L91