The project finance structure underlying PPP projects is a response to the agency problem arising from the differing and conflicting interests of various parties-sponsors and investors, lenders, contractors, suppliers, and government-in these partnerships. For the structure of PPP project finance, complex contracts and financing arrangements distribute the different risks among these parties.
In this context, Brealey, Cooper, and Habib (1996) argue that the widespread use of bank finance and the limited use of bond finance in PPP project finance is a response to the agency problem, and the consequent need to closely monitor infrastructure PPP projects in their early stages. The role of bank and bond investors follows the ownership structures of these two types of financing. The concentrated ownership of bank debt encourages lending banks to devote considerable resources to evaluating and monitoring projects on a continuing basis. It also facilitates the renegotiation of the debt should a project company encounter servicing problems. By contrast, the diffused nature of bond ownership makes it difficult to take concerted action if covenants are breached or if they require modification.
The contract structure of PPP project finance also has implications on incentives and project costs. Blanc-Brude, Goldsmith, and Välilä (2006) draw from insights provided by Hart (2003) on bundling and unbundling project contracts to provide evidence confirming that PPP projects cost more than traditionally procured projects. Their empirical results show a 24% increase in the capital costs of PPP projects. On balance, while unbundling will clearly reduce productive efficiency, the reduction in allocative efficiency for bundling may be balanced by improvements in productive efficiency. The ability to contract out investments also plays a role in choosing between bundled and unbundled contracts. Unbundling is superior if the investment associated with productive efficiency can be contracted out, but the investment associated with allocative efficiency cannot be contracted out. The converse is true if the investment for allocative efficiency can be contracted out.