Contrary to the Treasury's stated position (HM Treasury 2003), it is not simply that the higher cost of private finance relative to public finance is due to risk-the private sector is charging premiums well above this. Research into 64 PFI consortia commissioned by the Office of Government Commerce in 2001 has also shown returns to PFI shareholders at around 2.4 percentage points above what would be expected1 (PricewaterhouseCoopers, 2002). Rates of return to the consortia may be even higher after "refinancing".2 In this case, the debt maturity is often extended, representing a significant increase in risk for the public sector. This device has the potential to increase returns, because the public sector continues to pay back the debt at the old rate of interest. The increase in IRR is due to the nature of the IRR formula and the way it favours returns earned in the short term-refinancing turns back-ended cash-flow profiles into front-ended profiles. For example, investors of the Norfolk and Norwich PFI hospital increased their rate of return from 16% to 60% through refinancing. This outcome was described as "the unacceptable face of capitalism" by Edward Leigh, the chairman of the House of Commons Public Accounts Committee (Macalister and Carvel, 2006). The evidence of "excess returns" to private finance investors contradicts the claim that the higher cost of private finance is simply a function of the risks taken on by private shareholders, and represents a significant element of bad value for the public sector (Hellowell and Pollock, 2009). The evidence of earlier returns to shareholders also contradicts claims about efficiency incentives.
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1 The calculation was based on the average internal rate of return (IRR), a measure of the excess return of the investment above and beyond the cost of capital. Although Price water house Coopers presented the value as an overall return to the private investor it is actually the rate of return for subordinated debt and equity, which accounts, according to experience, for 10% of the projects' finance. This assumption is based on two omissions in the study. To calculate the overall rate of return (a) an actual gearing ratio (the split between senior debt as opposed to subordinated debt and equity), and (b) the actual cost of debt have to be known. The actual cost of debt was used in the comparator-so what was claimed to be a comparison of overall returns did not account for the possibility that the cost of debt contained an excessive premium.
2 Because PFI projects are less at risk of default after completion of the construction stage, the private consortia are often able to obtain credit on better conditions. This results in changes to the financial structure which allow investors of equity and subordinated debt to bring forward cash-flow, resulting in a higher rate of return. Although payment mechanisms are in place which allow the public sector to share in these gains, refinancing interferes with incentives for the private consortia to perform well over the whole life cycle of the contract since the private sector consortium has received a major proportion of its total returns in the early life of the contract (Asenova, Beck & Toms, 2007).