The contingencies of financial contracting can affect in a non-trivial way the performance of PPPs. Consider for instance how the rights are licensed when contractors face the risk of bankruptcy. If contractors are financially constrained, the risk of bankruptcy is not internalized when contracts are awarded. This is relevant, for example, at the auction stage: it can lead to aggressive bidding and success at the auction, with the government/sponsor paying the consequences later. Things are worse if, because of 'too important to fail' considerations, the sponsor finds it optimal ex post to intervene and rescue the project. The anticipation of such 'soft budget constraints' would contribute to a further distortion of competition at the auction. This could provide an argument for the sponsor to contribute to the initial financing of the project, but could also justify PPPs in order to transfer decision rights in the case of bankruptcy to a third party.
Softness of budget constraints is an illustration of a lack of commitment or lack of completeness of contracts, and the question is whether external finance can help in making budget constraints bind, thereby avoiding the opportunistic behavior of contractors. Recent literature on venture capital models the active monitoring and sometimes executive role of the financial intermediary for references and evidence). Whether finance is obtained through equity or debt, that literature underlines a trade-off between the benefits of risk diversification, which leads to a dilution of ownership of individual firms, and the benefits of monitoring resulting from a more concentrated ownership structure (Kaplan and Stromberg (2003).
These aspects lead to consider that quality of infrastructure reflects both exogenous and endogenous uncertainty and that the purpose of contracts is to disentangle their effects. It is thus important to identify, and find ways to filter out exogenous disturbances by using or indexing relative performance evaluation between the public sector and the private parties involved. Building property rights in PPPs' contracts must also consider the importance of financial contracting to align incentives that do not depart from public-good objectives. The negative effects of financial contracting rely on the incentives to accrue benefits to outside investors. These problems can be eluded when contracts bundle decision and other property rights for operating infrastructure projects.