Published date01 December 2011
Date01 December 2011
doi: 10.1111/j.1467-9299.2011.01944.x
This paper analyses regulation by contract in public-private partnerships (PPPs) for infrastructure
services. Although the benef‌its of competition for the market and subsequent regulatory contracts
are recognized, the literature also identif‌ies contract design failures.
When considering these limitations, it is useful to distinguish between contracts associated with
purely contractual PPPs (concessions) and contracts for institutionalized PPPs (mixed company).
Two cases from the Portuguese water sector are used to illustrate problems arising in the preparation
of public tender documents: the ‘best’ bidder is often not the winner. Often, risks are not allocated
correctly nor is effective monitoring ensured. Comparisons between the two types of contracts
show how external regulation can be useful in mitigating contractual problems. This examination of
bidding procedures and contract design yields several implications for policy-makers; in addition,
the study presents recommendations for improving regulatory contracts.
Competition in the market is absent in many infrastructure services. Some segments
of network industries, particularly water utilities, are natural monopolies. To achieve
production eff‌iciency, such markets should have a single operator. This situation can
harm the public interest when there are excess prof‌its (redistributing income from
customers to the monopolist) and reduced output causing misallocations (deadweight
losses). Without pressure from the capital market, the monopolist prefers the ‘quiet
life’: incentives for production eff‌iciency are blunted. One public policy response is to
create a sector regulator with the responsibility for promoting better performance and
meeting social concerns: ideally, to achieve levels of allocative eff‌iciency comparable to
those arising in the competitive marketplace and to achieve public policy objectives. Of
course, the sector regulator faces signif‌icant problems related to expertise and autonomy,
information asymmetries, regulatory capture, opportunism and authority.
An alternative to competition in the market is competition for the market (Chadwick
1859). In this case, the right to operate a monopoly is subject to an auction. The winning
bid would be the one to present the best offer (lower cost or higher rent), guaranteeing
that in a situation of suff‌icient competition (no collusive behaviour) the winner would
offer an average price close to the average cost, allowing for fair and reasonable prof‌its
(Demsetz 1968). The conditions of operation (rights and duties) are signed in a written
contract, leading to the term ‘regulation by contract’. The modern version of this kind of
relationships is labelled public-private partnership (hereafter, PPP). Indeed, a PPP is a
form of public procurement with cooperation between a public authority and a private
partner aimed at ensuring the funding, construction, renewal, management and/or
maintenance of infrastructure, or the provision of a related service.
In the EU, PPPs are classif‌ied into institutionalized PPP (mixed companies) and purely
contractual PPPs [for information about PPPs for infrastructures and provision of services
Rui Cunha Marques is in the Center for Management Studies (CEG-IST), Technical University of Lisbon. Sanford Berg
is in the Public Utility Research Center (PURC), University of Florida, Gainesville.
Public Administration Vol. 89, No. 4, 2011 (1585–1603)
©2011 Blackwell Publishing Ltd, 9600 Garsington Road, Oxford OX4 2DQ, UK and 350 Main Street, Malden,
MA 02148, USA.
in the EU and their classif‌ication, see COM(2004)327, COM(2005)569 or C(2007)6661].
These two models have very different features which are studied here with reference to
two municipalities. Purely contractual PPPs comprise concession, affermage [where the
operator does not support the investment], and management contracts. Note that outright
divestiture is not considered a PPP. Some features of PPP contracts include the sharing
of responsibilities and risks between the public and private partners (in principle, risk
is allocated to the partner better able to manage and mitigate it), a project life-cycle
approach, and incentive (output) payment schemes.
The impact of private sector participation and PPP contracts in infrastructure, including
water, has often been positive (Gassner et al. 2009). Most PPP contracts have provided
value for money and have helped to solve serious problems of coverage and quality of
service both in the developed and developing world. However, some outcomes have
been problematic, with failures in many PPP contracts, including breakdowns and early
termination of contracts. In fact, most PPP contracts are renegotiated. In a study for
Latin America (sample of 1,000 contracts), Guasch discovered that 75 per cent of the
water concession contracts were renegotiated on average 1.6 years after their signature
(Guasch 2004). Under this circumstance there is bilateral bargaining to restore a mutually
acceptable situation for the parties, which undermines the legitimacy of the original
contract award. Without competition at this stage, the operator will always have more
information on the implications of alternative contractual arrangements, putting the
private partner in a much stronger bargaining position (Bajari et al. 2005).
Most of the literature has focused on developing countries, where often the lack of
transparency and expertise within newly democratic governments, lack of procedures to
prevent corruption, and a national focus on industrialization might contribute to unsuc-
cessful contractual arrangements. Nevertheless, experience around the world suggests
that the failures of contract regulation are not a matter of stage of development: see, for
example, the cases of Atlanta in the US water sector, the airport of Montreal in Canada, or
the London underground in England.
This study draws lessons from a detailed analysis of two PPP case studies in Portugal,
one contractual (concession contract) and other institutionalized (mixed company) in the
local sector. The institutionalized PPPs have been little discussed in the literature but are
very important in some countries (for example, the Soci´
e d’economie mixte in France, the
Stadtwerke in Germany or the Empresa Mixte in Spain). This analysis represents a f‌irst-
step towards better understanding the full implications of widely-utilized institutional
arrangements. The two cities illustrate the issues raised by PPPs and different ways
municipalities have used and misused contractual arrangements. Future work could
focus on the how the political context and other specif‌ic situational factors play out in the
design of bidding documents and the implementation of contracts. Such studies would
amount to scholarly investigative reporting that shed light on stakeholder interactions,
target-setting, governance, and the development of incentives for strong performance.
The present study identif‌ies pitfalls in current procedures: we conclude that in these
cases the contract failures are even more serious than is generally recognized. Thus,
the comparison provides a conceptual framework for future studies that could focus on
detailed micro-processes associated with PPP performance.
Portugal has a population of about 10.7 million inhabitants and is organized into
districts, municipalities (the basis of the country’s administrative structure), and parishes.
Currently, Portugal has 18 districts, 308 municipalities and 4,257 parishes. In the European
context, Portugal is highly centralized and local authorities’ expenditures represent a
Public Administration Vol. 89, No. 4, 2011 (1585–1603)
©2011 Blackwell Publishing Ltd.

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