Financing PPP Projects with PVR Contracts: Theory and Evidence from the UK and Chile

Risk allocation is an essential component of a successful public-private partnership contract. For many of these projects, demand risk is large and mostly exogenous, which motivates considering contract designs that do not force the concessionaire to bear risk it cannot manage. In this paper we study present-valueof-revenue (PVR) contracts, which achieve this objective. Under a PVR contract, the regulator sets the discount rate and tariff schedule and frms compete on the present value of tariff revenue. The lowest bid wins and the contract lasts until revenue collected by the winning firm is equal to its bid. We provide a theoretical analysis comparing debt fnancing under a fixed term concession and PVR and show that, other things equal, debt fnancing is less risky under PVR and therefore debt-to-capital ratios can be higher. We also show that the often held view that PVR does not mesh well with fixed maturity debt financing is wrong, essentially because this view does not consider the fact that demand realizations are independent of contractual forms. Finally, we analyze the experience with PVR, considering two early examples from the UK that were fnanced entirely with debt and close to thirty PVR contracts in Chile, mainly for highways and airports. We conclude that PVR contracts have been at least as attractive for debt-financiers than their fixed term counterparts, and that PVR has helped materialize the efficiency gains that are possible when PPPs are financed with user fees