CRGP graduate student Henry Chan is examining a new hypothesis to explain the high incidence of renegotiation in long-term concession agreements between host governments and private investors. The abstract for his research project appears below:

Many governments around the world have faced difficulties meeting their infrastructure needs with limited fiscal resources. As a result, many governments have invited international private investors to participate in infrastructure development through schemes such as Private Finance Initiative, Build-Operate-Transfer, and Public-Private Partnership. Multinational Corporations (MNCs) are often promised favorable concession terms ex ante by the host government as compensations for the enormous risk associated with many international projects. Unfortunately on numerous occasions, the host government then failed to honor its commitments or initiated renegotiation ex post, with the infrastructure already built and financial resources exhausted. Thus, many MNCs find their return on investment diminished due to a host government's opportunistic behavior, along with many other risks to which the project is exposed over a long period of time. Guasch and Straub (2006) found that more than half of water and transportation projects in Latin America from the 1990's were renegotiated.

Other studies have shown that opportunistic behaviors are not limited to the host governments in public-private collaborations. Once a contract is signed, the host government is heavily dependent upon private parties to complete the project. During the construction, start-up and operations phases governments face high switching costs, in terms of time, money, and potential reputational damage, and opportunistic private parties are in a position to 'hold-up' the government sponsor and renegotiate for more favorable tarrif, tax and other regulatory terms.

Thus broadly speaking prior literature has focussed predominately on public and private sector opportunism as the explanation for ex-post renegotiation.

This study suggests an alternative view to analyze and explain the relationship between host governments and MNCs in infrastructure development deals that is more neutral than the adversarial and competitive views aforementioned. A real option pricing model is applied to determine the evolving value of the project at various stages. It is hypothesized that as the value of the project changes with its progress, the government and MNC reevaluate their relative risk-benefit ratio compared to the other party. If the relative risk-benefit ratio becomes exceptionally favorable to either party, the other party will either initiate renegotiation or change its behavior unilaterally to rebalance the risk and benefit shared between them. This new perspective suggests renegotiation as a necessary and efficient means to restore equitable levels of risks and benefits to both the governments and MNCs, instead of opportunistic behavior by either party. As a part of expanding knowledge on the above claim, this study will probe on the following areas:

1) the benefits and limitations of using real options model to reflect the evolving value of infrastructures

2) the level of risk-benefit imbalance that triggers renegotiation by either the government or investors

3) the governance arrangement that will ensure fair renegotiation in response to new information The finding in this interdisciplinary study will bridge knowledge in the multiple disciplines such as construction management, finance, political science, and international law.

Posted by rjorr at May 7, 2008 4:20 PM