Managing the execution of contracts

1. Managing the execution of contracts Julie de Brux IAE – University Paris I Panthéon – Sorbonne Permanent member of the Chair on the Economics of Public-Private Partnerships http://www.chaire-eppp.org CICA – IFI 2010 Conference Efficient construction and sustainable development World Bank, Washington D.C. February 11th, 2010

2. 1/ Motivation Previous presentations examined PPP challenges arising BEFORE the signature of contracts: • Which projects shall be undertaken? • Should the realisation of the project be done in-house or should it be outsourced? • If outsourcing is the relevant choice, how should the contract be awarded? • Which funding should be adopted? • Which guarantees should be given to the operator? • Which price regulation mechanism should be attributed to the operator?

3. 1/ Motivation What happens AFTER the signature of contracts is also very important All the more important than many potential opportunistic behaviours may arise • From: • The public authority • The private operator • Because contracts are: • Long • Complex • They imply specific assets • In order to: • Win an election • Capture additional rents • Etc.

4. 1/ Motivation Renegotiations appear as a symbol of the difficulties arising during the execution of contracts… …with different theoretical approaches • Bajari, Tadelis, 2001: • Trade-off between ex ante incentives and cost of renegotiation • Guasch, Laffont, Straub, 2006: • Renegotiations to compensate the operator’s ex post losses… as a sign of institutional weakness • Engel, Fisher, Galetovic, 2007: • Public authorities renegotiate during electoral periods to relax the fiscal constraint • de Brux, 2009: • Case studies showing that cooperative renegotiations exist and can make 3 winners: Public Authority, Private Operator and Users Renegotiate= Cost over-runs/ opportunism/ principal source of PPP failure

5. 1/ Motivation: • Research question: Under which conditions will parties cooperate during the execution of contracts, whereas, at first sight, they have different utility functions? • Method: • A theoretical model based on Incomplete contract theory [Hart, Shleifer, Vishny, 1997] + repeated games [Baker, Gibbons, Murphy, 2004] • Beginning of empirical tests based on econometrics and descriptive statistics

6. 2/ The model: Starting point: Hart, Shleifer, Vishny [1997] • Major source of disagreement between public authority (PA) and private operator (PO): • PA wants a high quality of service. • PO wants profits: he wants low costs of provision and he wants to charge high prices. • If PO finds a way to decrease costs of provision, he implements this innovation. And he does not care about the adverse effects on the quality of service. • PO has over-incentive to find a way to reduce costs. • Private provision of public services may become inefficient.

7. 2/ The model: DeBrux, Desrieux [2010]’s goal: • Showing that when parties care for future transactions and/or when they have several contracts together (multi-contracting), the previous conclusion is wrong: i.e. Private provision of public services remains efficient • Why? Because of a sort of « tacit dealing »: the private operator knows that if he has a cooperative behaviour (no over-investment in cost reduction with high adverse effect on quality), he has higher probabilities of renewal • If he does not respect the deal, the probabilities that he is renewed become lower • Application with the French intuitu personae principle: a certain degree of discretionary power

8. 2/ The model: Intuition of the model: $ Deviation Cooperation Penalty: lower probabilities of renewal time

9. 2/ The model: Results:

10. 2/ The model Second step: • Awarding several contracts to one operator is good for social surplus • However, if the operator has too many contracts: • There will be no incentives for other operators to answer the call for tenders • So, no possibility for the public authority to punish the incumbent operator if he does not cooperate (by replacing him by an other operator) • Thus, the incumbent operator may abuse of his dominant position: private monopoly: high prices, bad quality of service, etc. • Trade-off between: • Positive effect of multi-contracting • Negative effect of the lack of competition

11. 3/ Empirical test Putting theory to test… reaching testable propositions • There is a certain number of contracts below which it is in the interest of the public authority to award several contracts to the same operator (multi-contract effect) • There is certain number of contracts above which it is not in the interest of the public authority to award several contracts to the same operator (competition effect)

12. 3/ Empirical test Why an application to the car park sector? • Contracts involving a private operator and a public authority (660 French contracts). • Possibility for an operator to have several car park contracts in a same city -multi-contractual framework-. (Up to 10 car park contracts at the same time) • Some contracts have been renewed from one to 5 times (repeated games). • Possible adverse effects on quality if high decrease of provision costs. • Competitive sector (on average, 5 bidders/call for tenders).

13. 3/ Empirical test Some variables and their expected signs • Explained variable • Awarding of a new contract and renewal of expired contracts • Explanatory variables

14. 4/ Concluding remarks • An original result… • Whereas the general trend is to go towards more atomic markets… • …we show that, up to a certain extent, it might be socially efficient to award several contracts to a same operator. • … requiring • Operators valorising future and sensitive to reputation • No private monopolies • Low corruption and democracy