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 CICA – IFI 2010 Conference Efficient construction and sustainable development World Bank, Washington D.C. February 11th, 2010

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?

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.

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

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

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.

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

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

2/ The model: Results: STATICREPEATED GAMES 1 CONTRACT No incentive to cooperate Incentive to cooperate N CONTRACTS No incentive to cooperate High incentive to cooperate

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

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)

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).

3/ Empirical test Some variables and their expected signs Explained variable –Awarding of a new contract and renewal of expired contracts Explanatory variables Name of the variableExpected sign Real sign Significancy Number of contracts already signed with the same PA ++*** Number of contracts already signed with the same PA ² --** Number of other PA in the same region with which the PO also has contracts +-0

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