So far, the discussion has focused on the negative effect of anticipated renegotiations on the private partner's incentives to perform and risk exposure, assuming that it has already awarded the concession. Thus, expected contract revisions create a moral hazard problem. But it is clear that renegotiations also distort the private sector's bidding behavior in the initial tendering process, i.e. they create an adverse selection problem. To the extent that firms bidding in the tendering anticipate that a contract revision could be called for later, they do not deem the original contract terms proposed by the public-sector party as binding commitments. Hence, bidders seek to win the concession at any cost, regardless of what the current contract terms are. To maximize the probability of being awarded, bidders have incentives to bid aggressively, offering low tariffs or high transfers to public-sector party, ambitious investment plans, etc. Once the concession is granted, the private-sector party calls for a renegotiation to change its formal contractual commitments.69
Interestingly, a high degree of competition in the tendering process may worsen the negative effect of anticipated renegotiations on bidding behavior. If a private operator faces strong competition in the tendering, it will bid very aggressively to undercut the competitors and win. Next, if the operator wins offering very generous terms for the public sector, it is more likely to seek for a renegotiation. Guasch (2004) reports empirical evidence on concessions in LAC countries supporting this point. Most of the contracts were awarded through competitive bidding (78 %), and a few through direct adjudication and bilateral negotiation (22 %). Among the concessions awarded by competitive bidding, 46 % were revised at least once. In contrast, only 8 % of the concessions awarded by non-competitive procedures underwent renegotiations.70 Hence, competition in a tendering process might have induced aggressive, financially-unsustainable bids by the participants, and thus made it convenient for the winner to revise contracts afterwards. On the other hand, bilateral negotiation in non-competitive procedures might have granted favorable terms to the private partner, ruling out financially-unsustainable proposals but allowing for corruption and rent-seeking, and thus lessened the incentives to call for a concession renegotiation.71
It is noteworthy that competition and market structure have different effects on the contract renegotiation issue. On the one hand, higher competition in the renegotiation stage increases the bargaining power of the public sector, making it more able to resist unacceptable proposals backed by the private partner's threat of contract termination. Hence, since contract revisions that simply benefit the private-sector party are less likely to happen, competition reduces the incentive distortion created by renegotiations (Segal, 1998).
On the other hand, it was argued lack of competition might rule out aggressive bids that are financially doubtful, thus decreasing the probability of a future renegotiation that aims precisely at benefiting the concessionaire (Guasch, 2004). In this sense, someone would think that competition may increase the incentive distortion. But it is likely that it is not competition that generates more renegotiation but the lack of guarantees and weak enforceability of contracts, which leads to expected renegotiation and distortive behavior in the bidding stage.
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69 The case of the Lima airport illustrates an aggressive bidding under expectations of a future renegotiation. In the tendering process, a key variable was the percentage of gross revenues to be transferred from the private-sector party to the public-sector party. The winner consortium submitted a very attractive bid whose financial viability was questionable: it offered to transfer 47 % of revenues and to undertake an ambitious investment plan. But after winning the concession, the consortium demanded a renegotiation. Not surprisingly, the revision adjusted downwards both the revenue transfer and investment obligations during the concession period (Guasch, 2004).
70 The figures exclude telecommunications concessions.
71 The case of water concession in Cochabamba (Bolivia) illustrates why bilateral negotiation involving political affiliation reduces the probability of renegotiation. The Aguas del Tunari consortium was the only bidder in the tendering. Since the local partner in the consortium was owned by one of the most influential men in Bolivia, Aguas del Tunari awarded the concession despite omissions and irregularities in the tendering process. The contract entitled the private partner to a 15 % return for 40 years guaranteed by the public sector, so there was little incentive for the concessionaire to change the contract terms (Lobina and Hall, 2003).