Renegotiationin Public-Private Partnerships:
Theory and Evidence

17

Discussion Paper 2014 • 17
Eduardo Engel and Ronald Fischer
Universidad de Chile, Santiago, Chile

Alexander Galetovic

Universidad de Los Andes, Santiago, Chile+

Renegotiations in Public-Private Partnerships:
Theory and Evidence
Discussion Paper No 2014-17

Prepared for the Roundtable:
Public Private Partnerships for Transport Infrastructure:
Renegotiations, how to approach them and economic outcomes
27-28 October 2014,
George Mason University, Washington D.C., USA

Eduardo Engel1
Ronald Fischer
Universidad de Chile

Alexander Galetovic
Universidad de los Andes,
Santiago
Chile
Revised November 2014

1

Engel: Department of Economics, Universidad de Chile, Santiago, Chile. Fischer: Center for Applied Economics (CEA),
Department of Industrial Engineering, University of Chile, Av. República 701, Santiago, Chile. Galetovic: Facultad deCiencias Económicas y Empresariales, Universidad de Los Andes, Av. San Carlos de Apoquindo 2200, Santiago, Chile.
E-mails: emraengel@gmail.com, rfischer@dii.uchile.cl, alexander@galetovic.cl. We thank Eduardo Bitrán, Sebastián
Nieto-Parra and Juan Sebastián Robledo for permission to use their data on PPPs. Fischer and Galetovic gratefully
acknowledge the financial support of Instituto Milenio “Sistemas Complejos de Ingeniería”. We wish to thank Amanda for
helpful research assistance.

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RENEGOTIATIONS IN PUBLIC-PRIVATE PARTNERSHIPS: THEORY AND EVIDENCE

Table of Contents

Abstract .................................................................................................................. 4
1. Introduction ........................................................................................................ 5
2. A Simple Model of Renegotiations ................................................................... 8
Model ...................................................................................................................................... 8

3. Extensions ........................................................................................................ 13
Accounting for PPPs ............................................................................................................. 13

4. Evidence from Chile, Colombia and Peru ....................................................... 14
Concession programs ............................................................................................................ 15
The data ................................................................................................................................. 17
Standardized comparisons among countries ......................................................................... 18
Testing the predictions .......................................................................................................... 22

5. Conclusions ...................................................................................................... 23
References ............................................................................................................ 24

RENEGOTIATIONS IN PUBLIC-PRIVATE PARTNERSHIPS: THEORY AND EVIDENCE

Abstract

Public-private partnerships (PPPs) have the potential to increase efficiency and improve resource
allocation. However, contract renegotiations are common and make us question the benefits to PPPs.
Under current accounting standards, PPPs allow intertemporal reallocations of infrastructure spendingthat do not occur under traditional methods of procuring infrastructure and which allow governments
to escape the constraints of congressional purview. We review the theoretical results in Engel et al.
[2009a] as well as data from Colombia, Chile and Peru, comprising 610 highway PPPs and 540
renegotiations processes to verify these predictions. The data and original analysis comes from Bitran
et al. [2013], complemented with additional descriptive statistics. The empirical evidence supports thepredictions of the theoretical model.

Keywords: Build-operate-and-transfer, concessions, lowballing.
JEL classification: H21, L51, L91.

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RENEGOTIATIONS IN PUBLIC-PRIVATE PARTNERSHIPS: THEORY AND EVIDENCE“Cynics suspect that the government remains keen on PFI not because of the efficiencies it allegedly
offers but because it allows ministers to perform a useful accounting trick.”
The Economist, July 2nd 2009.

1. Introduction

Infrastructure provision via PPP has become an accepted mechanism for infrastructure provision in
many countries. This explains the rise from almost zero PPP investment in Europe in 1990 to almost€30 billion in 2006, before falling by one third in the aftermath of the financial crisis. Whenconsidering low- and middle-income countries, the numbers rise from approximately US$20 billion in1990 to more than US$160 billion in 2010, and with no ill-effects from the financial crisis2. The rangeof PPP investments range from highways, bridges, airports and tunnels to less conventional prisons,convention centers, hospitals, schools, sanitation systems and railways [Engel et al., 2014].
There are several reasons for the increased use of PPPs. One of them is the potential for efficiency
gains from packaging in one contract the final design, financing, construction and operation of a
project3. Second, some countries, such as the UK, used it to escape the constraints imposed by theMaastricht Agreements on public spending. Other countries believe, or act as if they believe, that PPPs
provide access to additional sources of finance. There are also political economy arguments for PPPs:
for example, some countries avoid the unpopularity of privatizations by transferring (temporarily)state assets to a private party for a limited time. The problem is that having a successful PPP program
must avoid a series of pitfalls that are observed in the programs of many countries.
In particular, governments should set limit on contract renegotiations, because they can overturnthe efficiency gains of PPPs. This is not easy and PPP programs are often riddled with contract
renegotiations. An early study is Guasch [2004] who studied over a thousand Latin American
concessions previous to the year 2000. One of his findings was that over 30% of contracts are
renegotiated, and in the case of roads, the fraction is 54.4%. Another one of his findings is that there isoften a bias towards the private party: in 62% of cases, tariffs were raised, and in a similar proportion
the required investment was reduced4. It is clear that in a long run contract, it will be necessary to
make adjustments in response to changes in demand, in quality standards, or for other similar reasons.
These adaptations of the contracts require renegotiations, and so long as they are conductedtransparently, can lead to welfare gains5,6. The tradeoff between the gains from flexibility in order to2

Though these PPPs suffered during the Asian crisis.

3

As in Hart [2003], Bentz et al. [2005], Bennett and Iossa [2006], and Martimort and Pouyet [2008].

4

For more on renegotiations of infrastructure projects, see Guasch et al. [2006a], Guasch et al. [2006b],
Guasch et al. [2007] and Guasch et al. [2008]. For developed countries, Gómez-Ibañez and Meyer [1993]
has also observed that renegotiations are common.

5

There is scope for corruption in renegotiations of contracts, even though the renegotiation itself is justified.
See Guasch and Straub [2009] for evidence of corruption in renegotiations.

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RENEGOTIATIONS IN PUBLIC-PRIVATE PARTNERSHIPS: THEORY AND EVIDENCE

adapt the project to changed conditions and the risk of opportunistic renegotiations is examined in
Athias and Saussier [2010]. However, this reasoning does not explain why it is often the case that there
is substantial renegotiation in the early stages of the project, and even during constructio7. In ourinterpretation, there are incentives to renegotiate. One case is when there are mistakes at the planningstage by the PWA, which is reluctant to admit the fact publicly, leading to contract renegotiation invery easy terms for the firm. These mistakes may range widely, but often include intentionally orunintentionally omitted components of the project. Unintentional omissions are a result of
incompetence at the PWA, but there are cases in which the omission is desired by the PWA. Thisoccurs, for example, when the PWA omits components of the project in order to lower its cost andreceive the approval of the Finance minister or other budgetary authority8.
However, there is an additional reason for intentional renegotiation of PPPs by government, andmoreover, it is a motive that is associated to PPPs and not to other types of infrastructure provisioncontracts. What is special about PPPs is that the project is financed by the concessionaire and that
future obligations to it are not registered as debt in the fiscal balance sheet. This can happen when theavailability payments are made by the State (the case of the PFI program in the UK), but even more sowhen user fees are the main source of resources for repayment. Thus the private party can provide
additional infrastructure, not included in the original contract, with costs to be paid either by futureusers or governments.
Infrastructure investment is popular among politicians and helps an incumbent during elections.
However, governments face budgetary constraints – in the case of developing economies spending
limits are often introduced by multilateral organizations. In the case of the UK, the Maastricht
agreements limiting public investment led to an abandonment of the Ryrie Rules used for PPP
investments. These rules included all PPPs as part of public investment, thus limiting their usefulness
for the current administration9. Many other countries have also used PPPs to escape budgetary
constraints. In Engel et al. [2009a] we showed that budget renegotiations can also be used to increasespending and escape the budgetary constraints, thus helping a government get reelected. We use theresults of that paper to examine the political-economy use of renegotiations.
The model starts with the observation that under traditional provision of infrastructure, a company ishired to build a project financed with fiscal funds, and is paid when the project is finished. The fiscal
funds must be approved in the budgetary process and are therefore restricted. An increase in spending
associated to the project requires either a reassignment of budgetary funds or going through thebudgetary process. Thus, it is difficult and costly to increase spending in the project, and we assume
that it is impossible under traditional provision.
6Note that PVI contracts can avoid some renegotiations or at least constrain its bounds Engel et al. [2001].
By making it easy for the Public Works Authority (PWA) to buy back a PPP project at a predefined value,
it can buy back a contested project and auction it again to a new bidder, with the additional investment.
Even if it does not do so, the threat constrains the bounds of the bargaining set.

7

Cantarelli et al. [2010] is a good reference to the causes of cost overruns in infrastructure projects (not only
PPP projects).

8

A recent study Rosenfeld [2014] shows that the most important cause of cost overruns in construction
projects in general (not circumscribed to PPPs or even infrastructure projects is: i) premature (i.e., poor)
tender documents, ii) too many changes in requirements, iii) unrealistic tendering prices. This is consistent
with our analysis of renegotiations of PPP’s, except for our assumption that these causes can beendogenous in PPP projects.

9

See Engel et al. [2013].

6

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RENEGOTIATIONS IN PUBLIC-PRIVATE PARTNERSHIPS: THEORY AND EVIDENCE

In the case of PPPs there is a difference, however, because the private party is paid over time andfinances the project by itself. Due to deficient accounting standards, changes in the future flows ofresources that the firm will receive as repayment are usually not included in the fiscal balance sheet.
Thus, an increase in future user fees, or an extension in the life of a PPP that charges user fees do not
require budgetary approval. In countries where availability payments are not included in the balance
sheet, government may increase the value of these future flows. This means that the present
government can bind the resources available to future governments in exchange for current
infrastructure spending by the PPP. In essence, in a renegotiation for additional infrastructure, the PPP“lends” to the current government in exchange for these future funds.
Engel et al. [2009a] presents a model with four predictions. First, under competitive bidding andrenegotiation, firms will make bids that are below costs. A standard interpretation is that thiscorresponds to cases of Winner’s Curse. However, there is empirical evidence that lowballing bids ishigher under weaker institutional frameworks, where renegotiations is easier, see Athias and Nuńez
[2008] and Athias and Nuńez [2009]. This is consistent with our prediction of the association ofopportunistic renegotiations and lowballing. Second, renegotiation includes not only compensation forthe low bids, but also additional investment. Third, these renegotiations occur early and fourth, a largepart of the cost of renegotiations falls onto future governments. In that paper we simplified theanalysis by assuming that firms have identical costs and there is perfect competition among bidders.
Further extensions of this paper would loosen these constraints. For example, if a firm has a costadvantage over the remaining bidders, it might use limit pricing, so the winner might not be placing a
bid below costs. On the other hand, if a firm has an advantage in renegotiation over the rest of the
field, it might be able to offer an lower bid than a more cost efficient firm, thus creating a further
inefficiency in renegotiations. If costs are equal, but there are few firms and there is a first priceauction, bids may also be higher than costs.
Another point to note is that consideration is that the desire by the government to engage inrenegotiation may depend on its probability of winning the election. Since the reallocation of future
resources is costly, a government that is sure to be reelected will not renegotiate the contract, while thedesire and extent of renegotiation depends on the likelihood of reelection without the increase inpublic spending associated to renegotiation. Note also that during renegotiation, it is easy for thegovernment to be a bad bargainer in exchange for political slush funds, which are useful to pay for
campaign expenses. The relationship between corruption and PPP renegotiations has been studied by
Guasch and Straub [2009].
The solution, noted in Engel et al. [2009a], is that in order to reduce the incentives to renegotiate, the
PPP and all its associated obligations should be included in the balance sheet of the government, andsubject to the same oversight as other budgetary expenses.
There is empirical evidence for the predictions of this model. Engel et al. [2009b] describes the extent
of renegotiations in the Chilean PPP industry up to 2006. The results were consistent with thepredictions of the model.
More recently, Bitran et al. [2013] have studied renegotiations of highways in Chile, Colombia andPeru. These authors examine 61 interurban concession contracts between 1993 to 2010. In Chile they
study the 21 interurban concessions (2,400 km) awarded up to 2004. They analyze 60 contractchanges, adding up to $2.1 billion, of which $0.9 billion was to be paid by future administrations.
They also include 17 additional years of contract terms (i.e., another cost on future administrations,which will not be able to sell these contracts as brownfield concessions). In Colombia the authors
studied 25 contracts covering 4,800 Km. They examined 430 contract changes worth $5.6 billion and
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RENEGOTIATIONS IN PUBLIC-PRIVATE PARTNERSHIPS: THEORY AND EVIDENCE

131 years of extension to the contract terms and add almost 1,000 km of roads to the originalcontracts. In Peru they examined 15 road contracts for $2.3 billion covering 5,500 km. These
concessions are newer, with an average elapsed time of 4.6 years, but despite this, they have beenrenegotiated 53 times. The cost has been $300 million and has added 9 years to the contracts. Thus themore recent data examined in Bitran et al. [2013] confirms the predictions of this paper as well as theprevious study of Engel et al. [2009b] for Chile.
This paper reviews the political economy model of Engel et al. [2009a] and the evidence supporting its
predictions. The paper is organized as follows. Section 2 describes the intuition behind the model inEngel et al. [2009a] and its predictions. We then present the evidence from Bitran et al. [2013] andderive the implications.

2. A Simple Model of Renegotiations

Model
The model is simple, with two periods, at the end of the first one we have an election to change orkeep the current administration. Social welfare depends on infrastructure services (other things equal),
and we assume a zero discount rate so social welfare is the sum of per period social welfare:U = u(I1) + u(I2)(1)

where u is strictly increasing and strictly concave and It denotes infrastructure services in period t. In
this setting, infrastructure lasts for a single period. This setting implies that not all infrastructure
investments are made in period 1. In a first approximation, both the PPP and construction industries
are competitive and the cost of a unit of infrastructure is $1. There are no costs of operation. The
construction industry and the PPP industry are competitive, infrastructure fully depreciates in one
period and each unit of infrastructure costs $1. Operation costs are zero.
Taxes per period Ti are exogenous, and the budget must be balanced:
T1 +T2 = 1 = I1 + I2

(2)

Maximizing social welfare subject to the budget constraint leads immediately to the result thatinvestment in each period should be the same: I1 = I2 =½. We assume (a big assumption) that Congress
wants to maximize social welfare, and uses spending limits in period 1 (I1) to achieve this. The
problem is that the executive includes, in its own utility function, the probability of being reelected.
The probability of reelection depends on infrastructure investment in period 1, so that the
government’s utility function isG(I1,I2) = u(I1) + p(I1)u(I2)8(3)

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RENEGOTIATIONS IN PUBLIC-PRIVATE PARTNERSHIPS: THEORY AND EVIDENCE

This utility function reflects that the government cares about social welfare only if it continues ingovernment. We assume that p is increasing and strictly concave. This is a standard formulation in thiscontext [Alessina and Tabellini, 1990]10. Note however that it means that, from the government’s pointof view, biasing expenditure towards the first period increases utility by increasing the chances ofreelection.
Conventional provision vs. public-private partnerships
In general, the provision of public infrastructure can be private (the case of a private sanitationcompany), conventional (government hires a construction company to build the infrastructure andpays the company out of current funds) and via a PPP11.
Congress authorizes expenditure of I1 = I2= ½ in period 1, and the government cannot exceed thislimit. However, PPPs have the possibility of increasing current expenditure and getting paid later, as
they finance the project themselves, and most importantly, these deals are not registered bycongressional oversight in most countries. Thus, there is the potential to make a credible promise of
future repayment, something that is not possible under conventional provision, where funding andpayment is period by period.
There are various possibilities of transferring resources to the second period: the government can granta term extension to the PPP, raise future used fees, or lower the quality standards of the project, among
others. As we show in Engel et al. [2013], these always involve a transfer of resources from futureadministrations and users, and allow the government to increase first period spending in excess ofbudgetary limits.
Conventional provision. As mentioned above, Congress allows the government an expenditure of at
most =½, a limit that cannot be exceeded, because there are no mechanisms for it. There is
procurement to an amount I1 = ½ from construction companies (here competition ensures thatinvestment is comparable). If ½ > T1, the government issues debt of an amount D = ½− T1. This meansthat I2 = T2 − D, since the intertemporal budget constraint always holds. Since period 2 spending in the
optimal case is I2 = ½, we have that T2 = ½+ D. This means that in this case there is no mechanism toshift spending between periods, and the government cannot achieve its desired spending pattern. Notealso that an alternative way for Congress to control spending is by putting a limit on the issuance of
public debt.
Public-private partnerships. In this case, the private firm does not only build the infrastructure
project, but it also operates and finances the project. The firm makes a bid for a payment of B (over thetwo periods) in order to build infrastructure to the amount ½, which is all that Congress allows. Given
the expenditure limits enforced by Congress, B ≤½.
Assume now that the contract is renegotiated before period 2, in order to increase infrastructure
investment by the amount W, in exchange for an additional amount R to be paid in period 2 to theprivate firm. The new contract specifies W in additional investment (to ½+W) in exchange forincreased payments, to be paid in the second period. Total payment is B + R. Thus, the agreement10

We can write p(I1) ≡ P(u(I1)), where P' > 0 and P'' < 0, then p' > 0, p'' < 0. Thus our formulation is areduced for of a case when the probability of reelection depends on the first period utility.

11

Henceforth we will not consider the case of privatization and will concern ourselves only with PPPs andconventional provision.

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RENEGOTIATIONS IN PUBLIC-PRIVATE PARTNERSHIPS: THEORY AND EVIDENCE

involves an intertemporal obligation that has not been approved by Congress and that can be used to
exceed the expenditure limits12. In equilibrium, the values of the variables B, R, W can be determined.
PPPs renegotiations and additional infrastructure spending
Suppose the government only faces the intertemporal budget constraint (I1 +I2 = 1) and is not limitedby the per-period supervision by congress. Then the first order conditions for the government’s choiceare

It is fairly easy to show that I*1> ½. Just to give the flavor of the proof, consider the case in which p’ =p’’ = 0, i.e. when the probability of reelection is constant and does not depend on infrastructure
investment. Even so, the fact that the government values the future less, leads to excessive expenditurein period 1. The FOC become:Note that only when the probability of reelection is p = 1 do we reproduce the efficient solution. Now,
it is easy to see that the higher the probability of reelection p, the lower the distortion in governmental
incentives, i.e.
/dp< 0, and thus whenever p < 1, we have that the desired first period spending is>½.
There is an additional effect, however, which comes from the fact that the probability of reelection
increases as first period infrastructure investment increases. Hence there are two reasons forgovernments to desire to increase first period investment.
Implementing the incumbent’s optimum via renegotiation
What is noteworthy is that using renegotiations, the government is able to achieve its desired
allocation of infrastructure investment. There are two things to consider here: first, the bargaining
power of each party; second, the degree of lowballing by the winning bidder. In Engel et al. [2009a]
we show that independently of the bargaining power of the parties, the government can always obtainits chosen allocation.
The reason for this is that as the firm obtains more bargaining power, the competition to be the firmthat builds the infrastructure project becomes more intense (in the expectation of profitable
renegotiation), increasing the extent of lowballing. In turn, lowballing implies that there are period 1
ex post free funds that the government can use, apart from any reallocation due to the possibility of the
PPP firm “lending” resources to the government to increase first period investment.
We assume that the government, following the spending cap set by congress, auctions a PPP
contract with period 1 investment I1 =½. Note that renegotiation leads to W in additional infrastructure12

It is possible to control these underhand fiscal loans, but they require an overhaul of the fiscal accounts
system, so that these hidden obligations are revealed.

10

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RENEGOTIATIONS IN PUBLIC-PRIVATE PARTNERSHIPS: THEORY AND EVIDENCE

in exchange for a renegotiated amount of R to be paid in the second period, we have that second period
investment can only be 1 – (B + R). Thus the utility of the incumbent is then:During renegotiation the concessionaire obtains a rent R ≡ R − W where the markup is given by its
renegotiation ability. In this first stage, we assume that all firms are identical in this respect. Then, an
increase in the rent, due to reduced bargaining power by the incumbent, increases low-balling, becauseof competition among firms. If we demote the extent of lowballing by L, then L = ½− B, where B is
the bid. By competition, we have that first period spending commitments by government are B + R
must equal first period spending ½+ W. Note that the effect is that in equilibrium, the firms lowball by
the extent they will obtain in the renegotiation process.
The important point is that the transfer implicit in the lowballing is a free transfer to theincumbent, which can use it to increase its spending in the first period, without it being at stake in therenegotiation process. Under the two assumptions of efficient bargaining and competition, this issufficient to achieve the desired first period investment by the incumbent. To make the point, we showthat when the concessionaire has all the bargaining power, the incumbent can achieve its desired
spending.
Private party has all the bargaining power. Since in this case the government does not obtain any
additional utility by renegotiation (because it is all appropriated by the firm), renegotiations keeps its
pre-renegotiation utility constant. However, this utility includes the resources saved by lowballing, thismeans that there are free second period resources. The incumbent’s utility of no renegotiation is: u(½)
+ p(½)u(½+ L), where the additional second period resources are due to the fact that the first period
expenditure cost less than ½. Thus the problem for the winning bidder –after being awarded thecontract– is to maximize its profits R − W by renegotiation, under this constraint:

We obtain the first order conditions of this problem and use the fact that by competition and the fact
the private parties do not have losses. This means that R = L +W , i.e., second period additional
payments are equal to the extent of lowballing plus the additional first period infrastructure
investment. We obtain the expression:u'(½+W)−p(½+W)u(½−W)+p'(½+W)u(½−W) =0
which is identical to (4)! Thus, even when the firm has all the bargaining power, the incumbent canuse renegotiations to achieve its desired allocation of expenditure.
Note that in this setting we get cost overruns, because the firm makes an offer that is below costs, but
this is not inadvertent, but endogenous to the model. The renegotiated amount R to be paid in thesecond period includes an amount to compensate the frm for its lowballing in its period 1 winning bid.

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RENEGOTIATIONS IN PUBLIC-PRIVATE PARTNERSHIPS: THEORY AND EVIDENCE

Government has all the bargaining power13. In the case in which the incumbent has all thenegotiating power, there is also no lowballing, since firms know that they will not be able to raise theirprofits through renegotiation. In that case, renegotiation takes place, but the cost of the additional
works W is equal to period two repayment R and we have straightforward case of government
attaining its preferred allocation of infrastructure investment by maximization of its utility.
One way of giving all bargaining power to the government is by a Congressional mandate that all
additional works in renegotiation should be awarded by the concessionaire to the winner of an open
auction for these additional works. In this case, there are no profits to the concessionaire even though
it pays for the works in the first period (and is receives the compensation in the second period). There
will be no lowballing, but the ability of the concessionaire to “lend” to the incumbent means that theincumbent is able to attain its desired allocation of investment.
In this model, the incumbent distorts the allocation of investment away from the optimal, in order toenhance its probability of being reelected. Second period infrastructure spending is reduced from its
optimal amount. A simple generalization of this model is to assume that in many cases the governmentis certain of being reelected and does not want to distort the allocation of investment.
Results. Notice that we have shown:
1. Governments include additional works during the renegotiation process.
2. Renegotiations occur early (during construction) so that additional works can be added.
3. The cost of renegotiation is passed onto future administrations (or users, in the case of user fee
revenue).
These predictions will be contrasted with the empirical evidence in Chile, Colombia and Peru below.

13

In Engel et al. [2009a] we show that this result is also true for intermediate case, where each party has
bargaining power.
12

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RENEGOTIATIONS IN PUBLIC-PRIVATE PARTNERSHIPS: THEORY AND EVIDENCE

3. Extensions

The section covers some extensions of the original model.
Stochastic renegotiation. A more realistic situation for the government is that the election is in doubt
only in certain cases, while in others it is fairly certain that it will be reelected. In the case of certain
reelection, the government prefers not to distort the allocation of expenditure across periods, since itwill be in power with certainty in the next period. Assume that, with exogenous probability r, there isa shock which makes for a weak government (after awarding the PPP in a competitive auction). In thatcase, the reelection probability depends in part on its infrastructure investments in the first period. We
model this as:

G(I1,I2) = u(I1) + pe(I1)u(I2),ewhere p ≡ πp + (1 − π) · 1 is a weighted average of the two probability functions. Now since thewinning bidder in the project will renegotiate with probability π, the equilibrium bid falls by πL.
Consider the case of all bargaining power to the firm. In the event of a strong government (which
occurs with probability (1 − π)), the resources the government saves as an effect of low-balling in thewinning bid can be spent in additional infrastructure investment. In the case of a weak government, weare back in the previous models, but the amount R that must be paid back in the second period to thefirm includes the additional amount to compensate the firm by lowballing in the case of a strong
government that did not need to renegotiate. Thus the distortion in second period expenditure is larger.
In the case where all bargaining power belongs to the government, there is no lowballing. Thus there
is no change in the investment in the case of strong governments, because it does not obtain its desired
investment at a price below cost. This also means that a weak government achieves its desired
allocation of investment, as in the previous section.
Bargaining differences among firms. Assume that one of the firms has more bargaining power than
the rest (and this is known). This means that the amount of lowballing it offers (while limit pricing)does not compensate totally for the rents it obtains from renegotiation. In this case, the government –unless it has all bargaining power, so there is no lowballing – cannot achieve its desired allocation of
investment across periods. The rents that the winning firm obtains will reduce the resources available
to the government, resulting in a constrained optimum.

Accounting for PPPs
The appropriate way of accounting for PPPs in government balance sheets has been an issue for a longtime. The solution Eurostat (2004) found was to make the decision based on the part of risks that theprivate party has to bear. If that party bears at least construction risk plus one of availability or demandrisks, the PPP is not included in the fiscal balance sheet. This decision seems to have been a
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RENEGOTIATIONS IN PUBLIC-PRIVATE PARTNERSHIPS: THEORY AND EVIDENCE

compromise between the forces pushing for the exclusion of PPPs altogether and those that found that
it was an unsound fiscal policy, as events would show14. More recently, several countries have been
considering stricter approaches without an implicit bias to PPPs, denoted by the “control approach”
because ultimate control determines whether to incorporate the PPP into the balance sheet (“Eurostat
Treatment of Public-Private Partnerships”, 29/10/2010). Another alternative would be to reconsider
the Ryrie rule that included all PPPs in the fiscal accounts.
A related important advance towards a sounder policy is the gradual incorporation of contingent
obligations associated to PPPs into the fiscal accounts. Recently, Eurostat has established a separate
set of accounts for contingent liabilities. See “Supplement on contingent liabilities and potential
obligations to the EDP related questionnaire”, Eurostat, 22, July 2013. Some Latin American countries(Chile, Colombia) have gone beyond this by applying standard financial tools to put a value on theseliabilities.

4. Evidence from Chile, Colombia and Peru

In this section we report on the evidence for the hypothesis presented in this paper. We begin with two
examples that illustrate how the Chilean Government has used renegotiations to circumvent
Congressional approval for increased expenditures.
The rainwater collectors. In 2001, there was flooding in Santiago, which led to political pressures on
the government to invest in main collectors that would drain the rain waters from flood-prone areas.
Since the government was unwilling to obtain the necessary resources from the budget or throughincreased indebtedness, it decided to renegotiate the contracts of the urban highways scheduled forconstruction so that they would build the drains. The sums involved were in the hundreds of millionsof dollars and required changes to the contracts of three urban concessions during the construction
phase. The initial payments for the additional works were scheduled to begin several years in the
future.
The San Antonio Bypass. The main port of Chile was hampered by the fact that trucks had to go
through the city of San Antonio to reach the port. The government decided to add a special accessroute to the port that bypassed the city. There were three options to finance the project: i) to fund itwith fiscal resources, ii) through an independent self-financed tolled concession or iii) as a non-tolledextension to the Route 78, from Santiago to San Antonio. The then President had promised the city,while a candidate, that he would not impose a toll on the proposed access. Even though thegovernment had ample access to the international credit markets, it decided to renegotiate the contract,
valuing the 8 km project at around US$ 45 million. The payment consisted in a substantial increase intolls, and a further increase in 2012. It is not clear whether the expected revenue from increased tolls
corresponds to the value of the project.
14

Observe that in its inception, the UK PFI initiative used the Ryrie rules. Under these rules, all PPP
investments were required to be included in the budget of its sector [Engel et al., 2014, p.25]. Irwin [2007]
cites the case of New South Wales (Australia), where the Auditor-general required that all assets andliabilities of the privately financed treatment plants be included in the State government’s balance sheet.

14

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RENEGOTIATIONS IN PUBLIC-PRIVATE PARTNERSHIPS: THEORY AND EVIDENCE

Concession programs
Chile. As mentioned in the Introduction, the Chilean concession program is considered among a
handful of well-established PPP programs (Hemming, 2005). Detailed data on concession contracts
are available on the webpage of the Ministry of Public Works (MOP by its Spanish acronym) and thequality of fiscal accounting can be described as at par with average OECD levels.
Chilean public infrastructure PPPs were launched in 1993 with the El Melón tunnel concession. As
shown in Table 1, between 1993 and 2006, MOP awarded 50 PPPs: 26 roads, 10 airports, three jails,

two water reservoirs, five public transportation infrastructure projects and four other miscellaneous
projects. At the time, roads represented 89% of the $11.3 B invested in PPPs.
By 2014 there were three hospitals and seven additional roads under construction, in addition toseveral large infrastructure projects (the underground Américo Vespucio Oriente, Part II and therenewal of the Santiago Airport PPP) that are planned to be auctioned in the near future15.
The history of Chilean PPPs has not been without contretemps: in 2002, at the time when the program
was at its most active, corruption was discovered in the PPP unit. In order to avoid losing personnel toprivate firms, the PPP unit devised a scheme to raise the remuneration of its employees16. Consulting
firms hired by the PPP unit would charge extra amounts. These firms would then hire the employeesof the PPP unit as experts, and paid them for non-existing work, thus raising their total remuneration.
The ensuing scandal sent the Minister of Public Works to prison, removed almost all of the executive
cadres in the PPP unit. For this reason, as well as the excess expenditure in PPPs in the previous years(studies, contingent guarantees, subsidies, etc), meant that there were almost no new PPPs for several
years, until the end of the decade, when there was a new push in favor of PPPs17.

15

Most Chilean seaports are managed under PPPs with excellent results in terms of productivity and total costs,
but they are usually considered separately, as they are governed by a separate legislation.
16

The extreme rigidity of the public system meant that salaries were non.competitive in the area.

17

More details about the Chilean PPPs appear in Engel et al. [2014] or in Bitran et al. [2013].

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RENEGOTIATIONS IN PUBLIC-PRIVATE PARTNERSHIPS: THEORY AND EVIDENCE

Table 1. Chilean PPPs and renegotiations, Engel et al. [2009a]
Number of
Projects andrenegotiations

Average

Pan American Highway
Interurban highways
Urban highways
Highways

8/28/24 (2)13/22/25
5/12/026/62/49

24
27
32
27

Airports
Prisons
Water reservoirs
Public Transport
Other

10/9/12
3/1/4
2/2/3
5/2/2
4/2/0

13
23
28
15
23

Other PPPs
Total or average

24/16/21
50/78/70

18
22

Original
investment
estimate(3)
2.875
2.118
2.421
7.414
384
221
120
157
169

Renegotiatedamounts(4)
843
426
1.332
2.601
48
113
24
26
1

1.051
8.465

Renegotiations
Total Investment as fraction oforiginal value

213
2.813

3.719
2.544
3.752
10.015
432
335
144
183
170

0,33
0,23
0,33
0,89
0,04
0,03
0,01
0,02
0,02

1.264
11.2790,11
1,00

Notes: Amounts in US$ MM. Includes cancelled projects. (2) Projects/bilateral negotiations/arbitration panels, (3) Excludes cancelled projects. (4) Includes the amounts
required to cancel 3 concessions.

16

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RENEGOTIATIONS IN PUBLIC-PRIVATE PARTNERSHIPS: THEORY AND EVIDENCE

Colombia. In Colombia, PPP partnerships in public infrastructure began in 1993, and by 2012,
approximately 32% of its road network was under PPP contracts18. By 2012, the government had
signed 48 contracts in the transport sector, and local authorities are also involved in PPPs. There wereserious problems with the first PPPs, leading to changes in the rules and new “generations” of PPPs.
There have been four “generations” of PPPs altogether, and in the last installment, the legal
environment for PPPs in Colombia is considered to be very good.
The first PPPs were not a success. The lack of road shows for international investors and the short
preparation times meant that only local firms could participate, and thus seven of thirteen projects
were negotiated directly without an auction. Among many other problems there was no detailed
project of the roads, so it was difficult to plan the eminent domain purchases for the roads, whichcaused long delays. Successive “generations” of PPPs improved on previous mistakes and the current
fourth generation has been fairly successful. The main public infrastructure PPPs are roads, of which
27 had been awarded up to December 2010, for a total of contract value of USD 6.5 Billion and cover
4,800 km of roads [Bitran et al., 2013]. Currently, there are 48 extant PPP projects in roads (WBI,
op.cit.).
Peru. Peru’s PPP program in public infrastructure is more recent than those of Chile and Colombia.
Though the initial legislation dates from 1991, only one road was concessioned in the 90’s. That PPP
was renegotiated several times in during its 13 year duration. A new start in PPP began in 2001, withthe concession of the Lima airport. Thus the program only really got going after that date. In 2008 a
new law modernized and added flexibility to Peruvian PPPs in public infrastructure. This means that
the Peruvian system for PPPs has learned from the errors of other countries and is consideredwell-conceived. This explains the relative lack of renegotiations, apart from the fact that the programis newer. Moreover, there are fewer, newer projects.
By 2010, there are 15 road PPPs, with a total initial value of $2.5 billion, i.e. it was still a relatively
small program in comparison to Chile and Colombia. Either because the program is newer or becauseof a better legal design, there have been fewer renegotiations.

The data
The following table, derived from Bitran et al. [2013], provides some basic information on road PPPs
in the three countries.
The following facts are interesting. First, renegotiations begin early, during the construction stage.
Second, each country has a large number of renegotiations, but there is a substantial difference
between the numbers for Peru and Chile and those corresponding to Colombia. Chile and Peru average
3.3. and 4.8 renegotiations per concession each, while Colombia has more than 20 per project. While
total fiscal cost, as a percentage of the initial value, is less than 20% in Chile and Peru, in Colombia
the fiscal cost almost triples the initial cost. Moreover, Colombia has increased the term by a third,
while the other countries have extended the term by less than 5%. On the other hand, Colombia has
managed to use renegotiations to change the design of the projects, adding on average 25% to theproject length, while the other countries have kept the length of the original projects.

18

World Bank Institute, “Public-Private Partnerships in Colombia: Scaling-up Results”, October 31, 2012.

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RENEGOTIATIONS IN PUBLIC-PRIVATE PARTNERSHIPS: THEORY AND EVIDENCE

Table 2. Characteristics of renegotiations in each country
Chile
Total road concessions
Avg. initial value (2009 MM USD)
Avg. term length
Mean length
Mean concession years elapsed
Concessions with renegotiations
Total number of renegotiations
Avg. time first renegotiation
Avg. cost of renegotiations per road
Avg term increase
Avg. length increase (km)Colombia

21
243
25.2
114
12.5
18
60
2.7
47.2
0.9
0

Peru

25
263
16.7
195
9.0
21
430
1.0
255.8
6.3
54.6

15
266
22.1
383
4.6
11
53
1.4
28.8
0.8
0

Source: Bitran et al. [2013].

Standardized comparisons among countries
The previous comparisons suffer from the fact that Peru has had concessions for a much shorter time(except for one early PPP). Appropriate comparisons should consider the difference in age ofconcessions before performing a comparison on the propensity to renegotiate.
Renegotiations during construction
A simple comparison is to examine the extent of renegotiations during construction. the prediction of
the model is that there will be substantial renegotiations during construction. In this respect, it is useful
to note that in general, in developed countries, the maximum increase in cost over the final estimatesfor road construction is of around 10%19. This is also the case for private infrastructure investments. In
Chile this is the case for road PPPs, as the value of renegotiations to the construction value is 5.4%.
there is excessive variance in these results. In the case of Peru, the equivalent value is 12.5% and in
Colombia it is an incredible 56% on average. Figures 1 use the raw data provided by Bitran et al toexamine the variation for all the road PPPs in their study.

19

See for example, “The Cost Estimating Manual for WSDOT Contracts, Washington State DOT, September
2008, page 14.

18

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RENEGOTIATIONS IN PUBLIC-PRIVATE PARTNERSHIPS: THEORY AND EVIDENCE

Figure 1. Renegotiations during construction as percentage of total cost
80%
70%
60%
50%
40%
30%
20%
10%
0%
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21
Chile

Peru

700%
600%
500%
400%
300%
200%
100%

0%
1 2 3 4 5 6 7 8 9 10111213141516171819202122232425
Colombia

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19

RENEGOTIATIONS IN PUBLIC-PRIVATE PARTNERSHIPS: THEORY AND EVIDENCE

It is clear from the figures that, first, Colombia is in a class by itself in the extent of renegotiation.
Second, there is a lot of variation in the extent of renegotiations during construction in different PPPs.
Peru and Chile look similar in terms of their renegotiation patterns. However, this may be due to thefact that Peru’s program is younger, so most concessions have run for a shorter period. We try tocorrect for this by looking at the extent of renegotiations of concessions with the same age. Thus we
examine the accumulated renegotiations of PPPs of a given age. Our standardized variable is the ratioof accumulated renegotiations in PPPs of age t to total investment in those PPPs. LetRiτ be the amountrenegotiated in year r in concession i = 1,.. . ,n and Ii be the initial investment in the concession. Then
Rit ≡ Στ≤t Riτ is the accumulated amount of renegotiations up to date tin concession i20. The ratio
compares the total amount renegotiated in all concessions of age t to the total investments. Figures 2

show this variable graphed for the three countries. This figure allows a better understanding. The
figure show the data divided by quartiles, so that the terms in (6) are divided into quartiles according
to the amount renegotiated21.
In the case if Chile we observe that some concessions even after 15 years, have no relevant
renegotiations (in the 25% percentile). Other concessions are renegotiated almost from the beginning.
On average, renegotiations as a percentage increase until the 14th year, and there are too few
concessions to make conclusions after that. In any case, the percentage even at the 75% percentile
does not reach 30% of initial value. Notice however than in the projects in that percentile,
renegotiations take place during the first four years, i.e., during construction.
In the case of Colombia the results are skewed by the disastrous effects of the first generation ofconcessions (the early concessions are the ones with more than 14 years since they were awarded. The
average renegotiation is also very high in all years, perhaps because the first generation concessions
weigh every year. When considering the median, the level of renegotiations is lower, but it increases
significantly at year 10, which seems to indicate that the second generation of concessions was not thatsuccessful in eliminating the problems caused by the initial design mistakes.
Peru has fewer concessions and they are younger, so the figure is not as informative. Nevertheless, theaverage and 75 percentile are higher than for Chile (though obviously far from the Colombian
numbers) from the third year onwards.

20

Where t is less than the age of PPP i.

21

That is, the 75 quartile considers the 25% of PPPs which renegotiate most at that age.

20

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RENEGOTIATIONS IN PUBLIC-PRIVATE PARTNERSHIPS: THEORY AND EVIDENCE
Chile
0,3

0,25

0,2
p ro m e d io
0,15

m e d ia n a
pctil

25

pctil 75

0,1

0,05

0
1

2

3

4

5

6

7

8

9

1 0

11 12 13 14 15 16 17

Colombia
10
9
8
7
6

pr om edi o5m edi an
pctil

4

25

pctil 75

3
2
1
0
1

2

3

4

5

6

7

8

9

1 0

1 1

1 2

1 3

1 4

1 5

1 6

Peru
0,35
0,3
0,25
p romed io

0,2

median
0,15

pctil

25

pctil 75
0,1
0,05
0
1

2

3

4 5

6 7

Figure 2. Profile of renegotiations by PPP age, quartile and country

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RENEGOTIATIONS IN PUBLIC-PRIVATE PARTNERSHIPS: THEORY AND EVIDENCE

Testing the predictions
This section describes the tests of the predictions of the model, using the results in Bitran et al. [2013].
Type of renegotiation. A first thing to notice is that most renegotiations are by mutual (or bilateral)agreement, so there is no conflict among the parties. In Chile 83% of renegotiations lead to these
agreements and it is also true for 98% of the cases in Colombia and in all cases in Peru. The arbitration
option, which reveals the inability to reach an agreement, is only chosen in 17% of the cases in Chileand 2% in Colombia.
In Chile and Peru, most renegotiations are led by the government, and to a lesser extent in Colombia,
with 40%, but where jointly led agreements have about the same percentage. This seems to indicate apolitical economy reason for renegotiations. This option transfers more of the fiscal costs onto future
governments than arbitration, and may be one of the reasons for the preference of governments for thistype of renegotiation.

When do they occur? In the standard interpretation of renegotiations, there should be more of themas time passes and more events that were uncertain initially come to pass. In the three countries,
however, more than half of the renegotiations took place during the construction phase, that is, within
the first four years of the contract. There are three interpretations for these observations. One is thatprojects were not carefully designed and require modifications. This can be described as theincompetent interpretation of renegotiation. The second interpretation is that government wants to add
additional works without going through the normal budgetary process and may also want to takeadvantage of the equipment already at the site. Third, the firm may want to recoup from lowballing its
offer. The last two interpretations work together in the model.
When is the cost of renegotiations paid? A large chunk of the cost of renegotiations falls onto future
governments, as predicted by the model. In Peru, only 14% of renegotiations have fiscal costs that fallon the current government. In Chile most renegotiations involve some costs falling onto the current
government, but 90% of renegotiations have some costs falling on future governments: by a
combination of extending the project term, raising future tolls, and assuming additional risks. In
Colombia, most renegotiations (88%) have costs falling on the current government. However, 6% ofrenegotiations involve future costs, and these account for 60% of all fiscal transfers.
The extension of the project term is one way of transferring cost to future administrations. When theterm of the concession ends, the government in place has a valuable asset that it can either operate byitself, obtaining toll revenue, or it can put it to auction, in exchange for additional works and revenues.
Chile and Peru have used term extensions, but this has added less than a year to the typical concession.
In the case of Colombia, on the other hand, the average extension has been of 6.5 years. This meansthat a future government that would have received the resources associated to the released PPP will bedenied their use (assuming a presidential term of less than seven years). However, this was the case of
the 15 early concessions whose lengths were extended by an average of 70%. More recent PPPs have
had a variable term, and term extensions have been avoided.
What do they pay for? Engel et al. [2009b] show that in the case of Chile, for those renegotiations
where data is available, 84% of the sums contracted were designated as additional investments, withthe remaining 16% designated as additional payments for works included in the original contract. Thisis consistent with lowballing by firms in the original auction, as suggested by our model.

22

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RENEGOTIATIONS IN PUBLIC-PRIVATE PARTNERSHIPS: THEORY AND EVIDENCEIn Colombia, only 5% of renegotiations involved road extensions, but these accounted for a third of
the total renegotiated value. As Bitran et al. [2013] mention, concession projects have been used toachieve objectives for which they were neither intended nor designed. These authors add that the costsof these additional stretches of road may be higher than registered in the data, because these extension
projects are also renegotiated, and the added costs are no longer included as part of the original
renegotiation. In Colombia there was one example of extreme lowballing that eventually led to thecancelation of the contract.

5. Conclusions

In Engel et al. [2013] we have shown that one of the benefits of PPPs for incumbent governments isthat they allow them to exceeded spending limits, because, as in England, PFI were not part of thebalance sheet, given the then current Eurostat rules. In this paper we note that there is a further
advantage to PPPs from the point of view of incumbent governments, which we studied originally inEngel et al. [2009a]. We showed that, because PPP renegotiations are outside of the purview ofCongress they can be used to increase government spending. This leads to a set of predictions:i) competitive firms can make lossmaking offers, expecting to recoup their losses thoughrenegotiation., ii) these renegotiations can also be used to increase government expenditure, iii)
governments will shift part of the payments onto future governments and iv) we will observe
renegotiations during the construction stage of the PPP. We describe data on renegotiations ofhighway concessions in Chile, Colombia and Peru that are consistent with the results of our model andalso show significant differences among countries in the magnitude of renegotiations.

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RENEGOTIATIONS IN PUBLIC-PRIVATE PARTNERSHIPS: THEORY AND EVIDENCE

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