Under/over-investment and early renegotiation in public-private partnerships

We consider a public-private partnership (PPP) in an infrastructure project, which requires specialized expertise during the construction stage for the infrastructure to be operational once completed. The cost of construction completion is higher both if the firm invests more upfront and if the government replaces the firm beforehand. On the other hand, there is synergy between construction and operation so that more investment makes the operating cost more likely to be low. We show that the potential benefit for the government of designing a contract that is renegotiation-proof is that it could be used as a tool to lessen moral hazard on the firm's side relative to a contract that undergoes renegotiation in mid-construction. However, this benefit vanishes when either moral hazard is severe, or the incentives to renege in mid-construction are strong. In those cases, it is less costly to motivate the parties to execute, in operation, a contract that was already renegotiated in mid-con
 struction than it is to motivate them to abide by a renegotiation-proof contract. For this reason, the government prefers to offer a contract that leads to renegotiation in mid-construction as a way to secure more investment relative to a contract that is renegotiation-proof.