Auctioning a concession helps dissipate rents and allows the ultimate beneficiaries (the users of the PPP-based infrastructure) to appropriate much of the consumer surplus, as long as there is no undue renegotiation of the concession terms after it is awarded. Hence, bidding criteria should be set pragmatically and with an eye at reducing the time inconsistency problem, whereby bidders have incentives to bid low, win the concession contract, and subsequently re-negotiate and extract additional benefits.
Such a time inconsistency problem is exacerbated when the concession is awarded by an insufficiently informed government agency to a bidder that offers the lowest user fees (the lower tolls in the case of a highway) or the shortest length of the concession period. Once the concession is awarded, the government is so to speak "on the hook" and winning bidders can take advantage of the situation to renegotiate and ask for additional government guarantees or other concessions.6 This problem is not mitigated by complicating the bidding criteria, for example, by awarding concessions based on a weighted average of several parameters, including user fees, length of the concession, amount of guarantees, and payments to the government (if any). Such an approach may not only not reduce the time inconsistency problem but may add unnecessary complications.
Renegotiation of contracts can transfer back risks to the government in a significant magnitude but in a less transparent manner. Analyzing a large set of infrastructure concessions in Latin America in the 1990s, Guasch (2004) finds that more the 50 percent of the PPP contracts are renegotiated, with renegotiation typically initiated by the concessionary company.7
There are at least two complementary ways of mitigating the time inconsistency problem that leads to post-auction repeated contract renegotiation. One is for the government agency to have more complete information about the technical and financial feasibility of the project so as to be better prepared at the time of the auction and, thus, more readily identify unrealistic bids. But even then, significant uncertainties and risks will remain. Since the bidder may not be able to predict well the future demand, in the presence of a fixed-term contract he/she may have incentives to renegotiate the contract as soon as it gets the concession award. Renegotiations are typically settled with extensions of the concession period.
Hence, a second, complementary way to reduce the scope for ex-post renegotiation is to use flexible-term PPP contracts. Under this modality, bidders compete by disclosing their target present value of user fee-based revenues (PVR), the government sets the maximum user fee and the discount rate to be used in calculating the PVR, and the duration (i.e., the number of years) of the concession contract is left open. The winner (i.e., the bidder that offered the lowest PVR) then operates the concession for as long as needed to collect such PVR, and once that is achieved, the concession contract expires. In addition to drastically reducing the scope for ex-post renegotiation, this auction modality can mitigate significantly the need for governments to provide guarantees to cover demand risks. This risk is transferred to the concession company, which manages and absorbs it over time, under a flexible-term contract. In the presence of less developed capital markets, this type of PPP contracts may still require government to provide some form of targeted guarantees, such as backstop facilities to give comfort to financiers.
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6. This time inconsistency problem is often referred to as the "winners curse"-having offered to charge unrealistically low user fees, once in possession of the concession contract, winners will try to recover some of their expected losses via repeated renegotiation.
7. Guasch, J. Luis (2004). Granting and Renegotiating Infrastructure Concessions: Doing it Right . WBI Development Studies. The World Bank. Washington, DC.