In the contracts there are non-variable pricing elements which relate to the phase where the project is. Such phases include the following:
• When work is already completed
• Supplies already purchased
• Labor and work not subject to inflation (contracted ex ante)
• Subcontracts
• Subcontracts with substantial cost variations already taken into account
Enhanced flexibility, in particular directed to accommodate changes in user needs, is important for the long-term projects typical of PPP, and may be achievable through well designed change-management contractual clauses necessary to limit potential abuses. However, enhanced flexibility will inevitably come at the cost of lower predictability and higher risk for the investing private-sector party, and of reduced effectiveness of the competitive selection process.
PPP procurements often develop along a long time horizon, 25-30 years or more. In such long period many things can change, so that there is a need for flexibility and adaptation of the contractual relationship far greater than in a more standard type of procurement. Some of the possible changes can be anticipated, in which case they may be specified in and regulated by the initial contract (e.g. changes in capacity). Other possible changes, however, may be hard to specify in the original contract, or may be totally unexpected (e.g. new incoming technologies that change substantially users' needs). In particular, when a party must undertake non-contractible investments that are specific to the business relationship, a contract protects it by limiting the other party's ability to 'hold up' the investing party asking for new terms of trade after the first party has committed its investment and is 'locked in' with the contractual relationship (Iossa, Spagnolo, Vellez, 2007).
Besides the benefits of generating certainty, fostering investments, and allowing for effective competition, the rigidity generated by contracts also brings about the costs resulting from reducing the parties' ability to adapt to novel circumstances that could not be envisaged at the contract drafting stage. The costs of reduced flexibility are larger the less the contract itself is adaptable to changes in the environment, that is, the fewer possible contingencies have been anticipated, described and regulated by the initial contract; and the more the environment and the parties' objectives may change in an unanticipated way along the contract life.
In PPPs, in particular, the large investment at the core of the project is the source of gains from contractual completeness and rigidity, while the long horizon for the service provision is at the root of the need for enhanced flexibility. This trade off can be softened by increasing the initial investment in forecasting future contingencies (e.g. possible changes in knowledge or technology) and in describing and regulating them in the contract. That is, the flexibility/predictability trade off can be attenuated by incurring in the cost of increasing built-in flexibility/adaptability of the contract. An example of this are the built-in adjustment mechanisms for tariffs and other payments, like the indexation clauses linking payments to price or cost indexes.
In a context of incomplete contracts, and looking at it ex post, renegotiation is a 'Pareto-improving' mechanism to redress inefficiencies caused by incompleteness or mistakes. To be specific, renegotiation provides the parties with the opportunity to adequate the original contract terms when unforeseen events occur, agents learn more on project design, new information becomes available, etc.30 Thus, the higher the degree of contract incompleteness, the more likely renegotiations or additional side (complementary) contracting will occur. Contract renegotiations are also affected by the interactions between project complexity, contract incompleteness, and features of the payment mechanisms. In this regard, Bajari and Tadelis (2001, 2006) argue that, in an optimal contract design, there is a trade off between the costs of ex post renegotiation of contracts with different payment mechanisms, and the ex ante incentives provided by these mechanisms. According to the authors, contract design costs are increasing both in the desired degree of completeness and in the complexity of the project to be implemented.