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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

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managing the execution of contracts

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

1 motivation
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 motivation1
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 motivation2
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 motivation3
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
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 model1
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 model2
2/ The model:

Intuition of the model:

$

Deviation

Cooperation

Penalty: lower

probabilities of renewal

time

2 the model4
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
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 test1
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 test2
3/ Empirical test

Some variables and their expected signs

  • Explained variable
    • Awarding of a new contract and renewal of expired contracts
  • Explanatory variables
4 concluding remarks
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
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