service disruption”. In an emerging market context, in which country risk is already assumed to be high, regulators may be equally concerned about sending negative signals to potential investors. Either way, if regulators fear bankruptcy then firms may be able to extract higher prices and maximise their profits by increasing leverage.

In this paper we show that the firm’s ability to increase prices by using leverage is determined by the regulatory regime. When regulation is high-powered, such as in price cap regimes, prices are unresponsive to costs. In such a case, the incentive to use leverage is limited and so we would expect leverage to be lower under high-powered regulation.

To investigate this we construct a sample of 124 transport concessions in Brazil, Chile, Colombia and Peru. We include a price cap dummy to capture the power of the contract. In pooled OLS regressions we find that the price cap dummy is positive but insignificant. It is highly likely however that the choice of regulation and other contract clauses (such as government guarantees) are non-randomly assigned to projects. To deal with this endogeneity we analyse how leverage changes _within_ projects when the cost of debt changes. We find that price cap firms make proportionally larger reductions in debt when the cost of debt increases. We conclude that for leveraged firms high-powered regulation reduces leverage, all else equal.

Our paper makes two further contributions. Firstly, we contribute to the scarce evidence base on the financing of infrastructure in developing and emerging markets. By sourcing financial statements directly from regulatory agencies we are able to create a panel of over 1,000 observations and analyse withinproject variation. In doing so, we question some of the prevailing logic including the view that infrastructure investors have a strong preference for debt over equity (World Bank 2012). If this were true, we would expect leverage to increase in profitability as it is easier for firms to meet lenders’ requirements (Yescombe 2007). Instead, we find that leverage falls in profitability. We also find that leverage falls as stock markets become more developed. Secondly, we contribute to the literature on incomplete contracting and renegotiation. The high frequency of renegotiation in Latin American concessions has been identified elsewhere (Guasch et al 2007, Guasch 2004) although the role of financial performance in triggering renegotiations has not been explored. We provide what is perhaps encouraging evidence: financial performance does not appear to be a significant predictor of renegotiation. This reduces the concern that regulation varies on paper but not in practice.

Our results provide useful insights for regulators concerned about capital structure and prudent financial management. Given that PPPs represent significant investments, particularly for developing countries, even small improvements in financial management can lead to substantial cost savings. It is therefore important to understand the motivations underlying firm’s financial decisions and how they respond to changes in the policy environment. This paper provides important evidence in that direction.

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