Do public-private partnerships benefit private sector? Evidence from an emerging market

https://doi.org/10.1016/j.ribaf.2018.10.002Get rights and content

Abstract

Purpose

We extend the literature on Public-Private Partnerships (PPPs) to understand the benefits of these incentive-compatible contracting arrangements to the private sector firms. We argue that the unique structure of PPPs helps in mitigating information asymmetry problem that drives underinvestment in the private sector of emerging markets and thereby enhances their investment efficiency. We test this hypothesis on PPPs that occurred in India over the last one decade.

Methodology

We consider the investment-cash flow sensitivity.

Findings

We find that, compared to the matched non-PPP investments made by the private sector firms, PPP investments result in significant reduction of investment cash flow sensitivity in the post-PPP investment period. Also, in the long run, the operating performance of the private sector firms improves in the post-PPP investment period. However, these benefits are sensitive to the nature of firm, commitment level of private sector and Government concessions. Overall, our results concur with the rising popularity of PPPs.

Originality

Our paper is the first study that examines the benefits of PPP for private firms.

Introduction

Public Private Partnerships (PPPs) are now used by more than 134 developing countries, contributing to 15–20% of their total infrastructure investment.1 For instance, with investments of around 400 billion US dollars, PPP investment make almost half of the market capitalization of the Indian capital market. Engel et al. (2008) point out that the growing popularity of PPP could be related to the failure of privatization program in many markets. More familiar examples of PPPs come from toll roads, light rail systems, bridges, tunnels, waste water treatment facilities, hospitals, courts, museums, schools and private prisons. A recent global survey by Deloitte2 reported that, “despite the very challenging economic environment in which the PPP industry is operating, the fact that the level of activity across the globe remains relatively stable, pays testament to the strength of the PPP model, and the huge penetration it has had over the last 20 years”.

In the case of PPP contracts, Government can rely on private sector's entrepreneurial expertise in efficiently managing government assets and private sector can reduce their underinvestment problem due to reduced information asymmetry through Government's active intervention, both in reducing regulatory hurdles and demand risk during operational phase of the project. Our paper investigates whether such inherent benefits associated with PPP investments can mitigate the information asymmetry problem associated with investment of the private sector. More specifically, whether such transparent and incentive-compatible contracts mitigate investment inefficiency problem faced by private sector firms (Myers and Majluf, 1984).

Our study is motivated by Besley and Ghatak (2001) theoretical model which shows that investment incentives are better when ownership of a project is granted to the partner who cares more about investment (private sector) rather than the party with investment technology (Government). Also, creation of a separate entity called Special Purpose Vehicle (SPV) isolates the venture from other investments of the partnering private sector firm. Such contractual arrangement improves transparency, accountability and attractiveness among lenders.

To our knowledge, ours is the first study to explore the corporate finance dimension of PPPs. Existing research mainly focus on the efficacy of PPP from Government or public welfare perspective (see Hart, 2003, Hammami et al., 2006). Understanding the role of such new and hybrid contractual arrangements can extend corporate finance literature on the role of new contractual agreements on investment decisions of firms. Existing literature posits that investment cash flow sensitivity reflects investment inefficiency due to market imperfections (Campello and Almedia, 2010). We extend this line of thought to see whether investment efficiency benefits, associated with PPP investments, can be transformed into reduction of investment cash flow sensitivity of participating private sector firms.

Our paper contributes mainly in three ways. First, given the growing significance and popularity of PPPs, our paper initiates more serious discussion on the sustainability of these hybrid contractual arrangements between state and private sector. PPPs, in order to be successful, should yield expected benefits for the participating private sector firms. Second, we provide a cleaner test to explain investment cash flow sensitivity relationship. In the current literature, it is difficult to conclude whether investment cash flow sensitivity is attributable to agency problem or information asymmetry problem. In other words, such positive relationship between investments and internal cash flows might arise either due to overinvestment problem (agency problem, as in Jensen, 1986) or underinvestment problem (information asymmetry problem as in Myers and Majluf, 1984). Both problems have similar prediction of positive relationship between investments and internal cash flows. Hence, existing empirical studies suffer from the joint-hypotheses testing problem. However, in our setting, PPP arrangement mainly reduces information asymmetry. Firm level agency problems will not change due to PPP structure.3 Agency costs of partnering private sector firms remain the same. Hence, any reduction in investment cash flow sensitivity is mainly attributable to mitigation of information asymmetry problem. This is also consistent with the idea that partnering private firm, in a PPP setting, mainly suffers from underinvestment problem. In summary, our paper not only tests a new hypothesis relating to the effect of PPP investment in private sector, but also sheds light on the attribution problem associated with investment cash flow sensitivity relationship.

Third, emerging markets like India are dominated by Business Group affiliated firms that have access to cheaper capital through their group-level internal capital markets (Khanna and Palepu, 1999). Hence, their dependency on internal cash flows would be minimal. However, standalone firms that operate in the same market, lack such internal mechanism and invariably depend on costly external markets. This situation can lead to underinvestment problem (Anshuman et al., 2015). Thus, PPPs can play an important role in alleviating underinvestment problem for standalone firms. We contribute to the literature by testing whether investment cash flow sensitivity significantly varies between Business Group affiliated firms and Standalone firms. Our results can highlight the role of nature and organizational structure of firm on firm-level investment cash flow sensitivity.

Our paper is related to Hoshi et al. (1991) and Pindado et al. (2011), in terms of understanding the role of organizational structure in reducing investment cash flow sensitivity. However, both papers suffer from attribution bias. For instance, in the case of Japanese Keirtsu structure, as studied by Hoshi et al. (1991), there is every chance that lower investment cash flow sensitivity is attributable to reduction in underinvestment problem due to internal capital markets or increase in overinvestment problem due to expropriation risk or cross subsidization risk associated with group structure. Whereas, PPP structure allows more accountability and transparency than a group structure. This is mainly because, the contractual agreement of PPP prohibits resource transfer during its operation phase. Hence, it reduces information asymmetry problem associated with Business Groups, sans expropriation costs.

We follow 65 infrastructure based PPP arrangements over 12 years (1999–2010). Our sample size is mainly dictated by the limitations in obtaining financial data on PPP ventures. We use Fazzari et al. (1987) methodology and compare investment cash flow sensitivity and operating performance for five years before and five years after PPP project signing date. We also compare them against industry matched control group firms. We find that, in the post-PPP signing period, PPP partnering private sector firms experience significant reduction in their investment cash flow sensitivity. These results are robust for several windows of pre and post PPP implementation period. However, the results are economically significant only for standalone firms. Business Group affiliated firms have much lower economic benefit by investing in PPP projects. This result highlights the underinvestment problem of standalone firms in emerging markets. We also find that investment efficiency benefits improve with deeper commitment level by private sector. In terms of long run operating performance, we find that PPP investments improve long run operating performance of participating private sector firms, however, operating performance improvements are positively correlated with Government concessions. This indicates that, concessions play an important role in improving operating efficiency. Overall, our results suggest that PPP investments benefit private sector by improving their investment efficiency and long run operating performance. Our evidence concur with the growing global popularity of PPPs in the last two decades.

The rest of the paper is organized in four sections. Our introduction in this section is followed by hypotheses development in Section 2. Section 3 describes data and empirical methodology. The results are presented in Section 4. Section 5 concludes.

Section snippets

Structure of PPPs

PPPs are generally defined as long-term infrastructure related contracts, where the same private sector partner engages in both construction and operation of the project. Compared to the traditional Government contracting, where construction and operation are executed as separate contracts, PPP allows bundling of contracts. PPPs are also different from privatization programs, as the objective of the contractual agreement with private partner is to improve the operational efficiency of

Data and methodology

We obtained financial statements of participating private sector firms from The Prowess, a database maintained by the Center for Monitoring Indian Economy (CMIE). PPP project level information is hand collected from Public Private Partnerships database, maintained by Ministry of Finance, Government of India (www.pppindiadatabase.com). We identified 249 projects from the Indian Ministry of Finance website. However, our final sample is limited to 65 PPP projects for two main reasons: 1. Most of

Determinants of PPP investments by private sector firms

We run the following logit regression model to estimate the determinants of PPP investment by private sector firms in India.PPP Dummy=α+β1CashFlowj+β2Investmentj+β3Growthj+β4Sizej+β5Leveragej+β6Agej+β7GroupDummyj+ϵjHere, firm and year is denoted by i and t, respectively. In the above equation PPP Dummy takes value 1 for PPP investment firms and 0 for matched non-PPP investment firms. Table 5 reports results based on a Logit model. It is important to note that bidding information is not

Conclusion

Existing literature on Public-Private Partnerships (PPPs) mainly focus on their role in improving service quality of public sector and public welfare in general. The growing global popularity and significant involvement of private sector in PPPs merit more research by extending to understand the role of PPPs on private sector firms. More specifically, to understand the benefits that make private sector firms to engage in PPPs. Apart from its global significance, we argue that the contractual

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