In PPP contracts the regulator is expected to act in the public interest and has considerable, although bounded and accountable, discretion in its decisions over tariffs and service standards. Some have argued that the fundamental challenge for regulatory design is to find regulatory governance mechanisms that restrain the degree of regulatory discretion over substantive issues such as tariff-setting (Levy and Spiller, 1994). Others have taken the view that a certain degree of regulatory discretion is inevitable (and even desirable) and hence the fundamental problem is how to establish governance arrangements and procedures that allow for a non-trivial degree of bounded and accountable discretion (Stern and Cubbin, 2005).
An important issue that calls the attention to shape PPPs contracts to reduce inefficiencies has to do with governance issues. In particular, transparency to tackle corruption practices, which in represent a widespread problem in countries with large project infrastructures portfolios. Contract design is an effective mechanism to improve governance since market forces cannot discipline politically-protected public buyers that misbehave, stringent disclosure requirements are also seen as a potentially powerful remedy (Rose-Ackerman, 1999; Kaufmann, 2005). The direct costs of disclosing information on contract terms and performance evaluation appear to be rather small in general (see e.g. Leuz, 2007), and even more so for repeated non-PPP procurements and large infrastructure projects like PPP. But in the case of contract design procurements tend to be infrequent for the particular public buyer, much larger, more complex, and often specific to particular assets. These features make benchmarking and other standard forms of outside control more complex in PPP compared to traditional procurement practices. At the same time, stakes are higher than in standard procurement, so bad governance can be much more costly.
In terms of contract designs, transparency and accountability are important to ensure sustainability. But transparency and accountability depend on exogenous and endogenous aspects that shift the conditions of contracting in PPPs. Some aspects can be internalized in contracts, as Iossa, Spagnollo, Vellez (2007) assert, given the identification of the following conditions:
i. Characteristics and trends of the targeted sector and its market structure (Exogenous)
ii. Degree of macroeconomic instability (Exogenous)
iii. Country's regulatory and institutional framework (Exogenous, sometimes endogenous when the PPPs contracts depend on legal reforms)
iv. Contract design and management, in particular the payment mechanism and the risk allocation built-in the contractual terms (Endogenous)
Therefore contract design should focus mainly on (iv) in order to guarantee efficiency, accountability an sustainability. Making the public-sector party accountable for its actions so as to provide adequate incentives is not an easy task. First, public-sector relies heavily on experience to contract the right incentives. Such experience is essential because as specific sector knowledge accumulates, the public authorities could standardize parts of the contracts for that specific sector as a means to reduce the likelihood of contract and output misspecification (Iossa, Spagnollo, Vellez; 2007).
In addition there contract design must recognize the distinction between regulatory governance and regulatory substance. Regulatory governance refers to the legal design of the regulatory system, institutional arrangements, and the processes of regulatory decision-making. It includes issues such as regulatory commitment, clarity of roles and functions between the regulator and policy makers, regulatory autonomy, the organizational structure and resources of the regulator, and issues such as transparency, participation, accountability, predictability, proportionality, and nondiscrimination, whereas regulatory substance refers to the content and outcomes of regulation, such as tariff-setting or service standards, and their impacts on consumers or utilities (Eberhard, 2007).
Transparency is also often compromised in regulatory contracts, such as concession agreements or power purchase agreements. Few of these contracts are open to public scrutiny. Government officials and private operators often justify such secrecy on the grounds of "commercial necessity or competition." But it is unclear why the secrecy is needed if the operator has been granted a de facto or de jure monopoly that eliminates any possibility of competition, at least for a significant number of years (Mwenechanya, 2006).
When there is no access to these contracts, it should not be surprising that the general public tends to assume the worst (that is, excessive profits or corruption). This, in turn, leads to a lack of trust in the regulator and government in general. Transparency requires a set of measures that assist all stakeholders to understand and have confidence in regulatory processes and decisions. Such measures include the following: clarifying the objectives and functions of regulation; stakeholder consultation in the process of developing new regulatory methodologies and standards; publishing final standards, regulatory contracts, and regulatory methodologies, including scheduled tariff review procedures and timetables; public hearings where stakeholders can make submissions and inputs into important regulatory decisions; written public explanations of regulatory decisions; prescheduled independent regulatory reviews and impact assessments; accountability through appeal mechanisms; and open access to information. Transparency measures provide a common understanding of the "rules of the game" and how they are applied (Eberhard, 2007).
In terms of accountability it is important to stress how contracts may improve it compared with other conventional procurement mechanisms. The most important benefits of PPPs relative to conventional procurement arise from the efficiency gains associated with private management of relevant risks and enhanced government accountability, rather than from access to private finance.
The key benefits from PPPs relative to conventional procurement (where the government is responsible for investment, operations and all project risks) are "potential", in the sense that they will only be realized if the public sector rises to the challenge of appropriate contract design and monitoring and if private sector performance is spurred by the disciplines of transparency and competition where feasible (especially for the right to provide the specified services). Benefits include:
• Enhanced government accountability. Strategic clarity is achieved by focusing government resources on contract design and management of contract outcomes (procurement, monitoring and performance evaluation), which in turn facilitates accountability. Accountability enhances access to increased levels of local and foreign private finance. PPP projects are ultimately financed by local consumers through user charges and/or by taxpayers through (hidden or explicit) top-up subsidies or direct payments. To the extent that there is no dedicated stream of user charges to fully fund the provision of the public service, PPPs are an additional claim on public resources just as conventional procurement, requiring a stream of payments to be set aside to meet the obligations entered into under the contract.
• Transfer of appropriate risks to private sector management, generating "value-for money" (defined as the optimum combination of whole- life costs and quality to meet user needs). While planning and regulatory risks are mainly borne by government, design, construction, operation, third-party liability and latent defect risks are typically more efficiently borne by the private provider (with demand or volume risks typically allocated between both parties). The main gains so far appear to come both from avoidance of time and cost overruns during the design & build phase (through fixed price & date certain contracts for asset provision), and from improved operational performance - driven by private sector commercial and managerial skills and incentives, and adoption of best practice technologies and innovative practices. It is still early for the expected long-term operational benefits of PPP procurement in terms of whole- life costing and locked-in standards to have become apparent.
But contracts should be viewed with caution because while transparency and accountability may be internalized, they only tackle generic risks. Generic risks deal with mechanisms to prevent major failure in operation and management. If public sector has accumulated experience more sophisticated contracts are needed to allocate risks into parties depending on the magnitude and conditions of the infrastructure sector. In such way allocation of risks and benefits can reduce significantly transaction costs. This is why we see in many countries that have developed substantial experience in PPP contracts, specialized units to design contracts where management is separated from industry regulators to avoid conflict of interests (Monteiro, 2006).