THE POTENTIAL FOR CORRUPTION IN PUBLIC PRIVATE PARTNERSHIPS – THEORETICAL ASPECTS AND SOME POLICY IMPLICATIONS

approaches how this

I. Introduction

Cooperations between the public sector

and private enterprises, so-called

Public Private Partnerships (PPPs),

have some historical pedigree supplementing

or replacing the «traditional»

governmental responsibility to provide

and/or produce services of general

economic interest, in particular in infrastructure

– water and sanitation,

prisons, or schools. These cooperation

models, being very different in design

and form, in general have to balance between

the managerial autonomy of the

private partner and democratic accountability

of the public body involved.

They are characterized by horizontal

relations and shared responsibilities between

the partners (Hodge 2006, M?rth

2009). They therewith epitomize the

fact that the cutting lines between the

public and private sphere are blurring

and have to be re-evaluated.

Overall, PPPs are designed to raise

potentials for a – quantitative and qualitative

– improvement of public services

due to enhanced financial, managerial

or technical efficiency (Klitgaard 2012;

Kwak, Chih, and Ibbs 2009). Having an

«iconic status around the world» (Hodge

and Greve 2010, p. 8), they are often

viewed as a sophisticated and professional

alternative for modern infrastructure

management. This promise as well as

optimism from PPP advocates in many

cases did not fully realize. The reasons

can be endogeneous to the design of a

single project, or more general exogeneous

factors in the execution process

of PPPs (for examples e.g. Hodge and

Greve 2007). Several weaknesses could

be mentioned here, as e.g. deal complexity,

the need for long-term equity

or problems related to the calculation of

public sector costs (Hodge 2006).

Even if the process of PPP implementation

and execution seems to be

comparable to agreements on other

forms of shared responsibilities between

the public and the private sector, there

are relevant differences, in particular

regarding contract duration and design

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as well as the composition of actors involved.

These characteristics of PPPs,

so our hypothesis, may make them also

particularly vulnerable to corruption,

even if a fair amount of literature refers

to the general control-effect of private

sector inclusion (e.g. Sclar 2000).

Hence, this article conceptualizes

from a theoretical viewpoint the vulnerability

of PPP models for corruption

against the backdrop of contract theory,

principal-agent theory and transaction

cost economics. Despite some of the

«channels» for corruption in PPPs resemble

the ones regarding other forms

public-private collaboration, due to the

characteristics of PPPs, there are specific

points that have to be highlighted

(Klitgaard 2012). The assumed (higher)

vulnerability for corruption is induced

by the multi-level characteristics of

PPPs, the incomplete contract they are

based on, and the underlying life-cycle

concept, including long-term relations

and «repeated games».

Our contribution to the ongoing

debate on the use of PPPs therewith

is twofold: first, an issue more or less

neglected by the pertinent literature is

analyzed theoretically. Second, tackling

the question of the origins of corruption

in PPPs is all the more relevant as

these instruments are used not only in

developed countries whose legal order

may shield PPPs sufficiently against

corruption, but also in developing countries

and emerging markets that do not

provide these legal instruments. Hence,

carving out the vulnerable points in

PPP arrangements may not only rise

awareness regarding this problem, but

also may enable decision makers to install

appropriate control mechanisms,

if need be on project level.

II. Public Private Partnerships

as new Instruments

of Service Provision

Budgetary restraints and the pressure

on public goods, particularly on

existing network infrastructures led

to a redefinition of the private and the

public sphere and responsibilities in

many countries. Private investment, or,

more general, private sector inclusion,

is discussed as a potential solution for

the altering challenges of the public

sector. This inclusion can take place

in different guises – as full or partial

privatization, or as joint projects in

the form of public private partnerships

(PPPs) between the public administration

and private firms that ensure

adequate control rights for the public

sector over the crucial aspects of service

provision (Demuijnck and Ngnodjom

2011; Marques and Berg 2011). PPPs

constitute an «alternative to contracting

out and privatization, and thus they

are seen as a qualitative jump ahead in

the effort to combine the strong sides

of the public sector and the private sector

» (Hodge and Greve 2007, p. 545).

They also provide an opportunity in the

sense of «entrepreneurial government

movement» (Bloomfield 2006), as they

do not only rely on private resources,

but also market-oriented strategies with

regards e.g. on competition and performance

contracting. Generally spoken,

the implicit assumption of a better value

for money in PPPs is derived from

the neo-classical view of markets under

perfect information, even if empirical

evidence for their superior performance

remains limited (Hodge and Greve

2007; Reeves 2008).

Focusing on the opportunities of

this form of cooperation, PPPs have

some historical pedigree, in particular

in the US. Within the EU multi-level

system of the European Union, the

PPP approach was implemented at

least with the «EU Green Paper» from

2004. Additionally, national initiatives

in the individual member states target

sustainable cooperations with the

private sector – in some cases in the

form of gold-plating, implementing

even stronger incentives to use PPPs

in infrastructure and service provision.

These initiatives demonstrate the

political will to use the instrument of

PPPs in a more systematic way on the

European level as well as in most EU

member countries; similar initiatives,

task forces or PPP laws exist in most

countries worldwide.

Despite this increased attractiveness,

the theoretical analysis of these «new»

partnership models remains poor.

Moreover, the term «PPP» itself is

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still lacking a precise, widely acknowledged

definition (Bud?us and Gr?b

2007; Hodge 2006). They are neither

hierarchies nor markets, but something

in between – relational arrangements

based on contracts, but also on trust

and (long-term) commitment (M?rth

2009). Hierarchy is replaced, and only a

limited delegation of authority between

the partners is given, raising questions

regarding accountability (Behn

2001; Koenig-Archibugi 2004). These

characteristics constitute a relevant

distinction against other contractual

arrangements in infrastructure provision

(see e.g. Savas 2000).

The prevalent PPP definitions typically

focus either on the players involved

or on procedural aspects of these

partnerships. Bloomfield (2006) defines

PPPs as complex, long-term contracts

that provide a combination of services,

construction, or financing in return for

access to public funds or user fees. In

quite a similar vein, but focusing on

infrastructures only, Grimsey and Lewis

(2005) define PPPs as arrangements

whereby private enterprises participate

in the provision of infrastructure.

Marques and Berg (2011) see PPP as «a

form of public procurement with cooperation

between a public authority and

a private partner» (Marques and Berg

2011). Linder (1999) broadly defines

the term PPP as «rubric for describing

cooperative ventures between the state

and private business», while Hodge

and Greve (2007) perceive «cooperative

institutional arrangements between

public and private sector actors» as

PPPs. To sum up, the decisive factor of

a PPP is the interest of both partners

involved, and not the specific sector,

as the general concept can be applied

to almost all sectors of public service

provision.

Based on this approach, PPPs in

the sense of our study are contractual

agreements between at least one private

enterprise and the public sector that

comprise more than one value-added

step or level of the respective project.

At least two value-added steps, i.e.

planning/project development, construction,

management, operation and

maintenance, as well as reconstruction

(or removal) have to be consolidated

within a project to fit this definition.

This multi-step approach of PPPs, an

equivalent to traditional bundling of

tasks at the government’s site, is the

most relevant distinction versus other

forms of public cooperation with the

private sector, e.g. outsourcing/public

procurement. Moreover, in each PPP,

some control rights remain with the

public partner, while the private company

enjoys some leeway to generate

cash flow. Consequently, a complete

material privatization cannot be classified

as PPP. While in the case of institutionalized

PPPs an independent legal

entity, a mixed company, is created,

in the contractual PPPs we focus on,

a (long-term) contract between the two

parties is established (Bud?us und Gr?b

2007; Marques and Berg 2011). While

the former cooperation form is characterized

by the pooling of the resources

within one new organization, the latter

one is a terminated agreement with the

public sector being the constituent, the

private company being the contractor

– a risk-sharing arrangement with the

private partner taking over (at least

some) financial responsibility (Bud?us

und Gr?b 2007).

The duration of PPP projects varies

between one and thirty years, with mere

service and management contracts being

of relatively short-term duration,

while PPP designs which include the

construction of an asset and that are

refinanced by user fees are usually

based on longer contract durations.

In particular, long-term PPPs, which

may involve several generations of civil

servants, but also private managers and

citizens, receive specific attention, as

the concept of action and liability may

be affected in these cases (Bloomfield

2006).

The commercial risk of failure is

mainly borne by the public sector in

(short-term) projects that do not affect

the ownership of the asset (which

remains with the public sector). In

PPPs where a direct contact between

the private company and the customer/

user exists (i.e. concessions and the

Build-Operate-Transfer/Build-Own-Operate/

Build-Own-Operate-Transfer PPP

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variants), the private partner has to

shoulder the main or at least a high portion

of the commercial risk (Iossa and

Martimort 2014). This is caused by potentially

insufficient revenues relative

to its costs (high upfront costs must

be refinanced over extended periods

of time), while protection mechanisms

designed to reduce the commercial risk

to the private company by guaranteeing

a fixed or minimum revenue stream

are not always in place. Generally, the

number of contingencies regulated by

the respective contract differs amongst

countries and sectors, respectively (Iossa

and Martimort 2014). Hence, even

if the commercial risk can be fixed in

the contract, in particular in developing

countries proper enforcement

mechanisms are often missing, or the

inclusion of such clauses depends on the

bargaining power of the private firm

that may be limited.

The expectations and interest – as

well as the incentives – related to the

socio-economic outcomes of PPPs differ

substantially among participants

and stakeholders. Nonetheless, valuing

PPPs as cooperations does not

cannibalize their contractual nature

that is based on different interest. As

Markovits (2004) argues, «promises

generally, and contracts in particular,

establish a relation of recognition and

respect – and indeed a kind of community

– among those who participate in

them […] even though contracts typically

arise among self-interested parties

who aim to appropriate as much of the

value that contracts create as they can»

(Markovits 2004).

The public partner focuses on its

need to procure additional capital as

well as to attract managerial competences

and technical skills – which are

of special relevance in the case of technologically

complex infrastructures like

water supply, sewage systems, energy,

and telecommunications – without losing

the political control over infrastructure

provision. Even if the evidence of

higher efficiency in the private sector

is not unquestioned in literature, in

fact the private company may be more

accountable to its customers and to

the public partner due to the existence

of a contract that defines duties and

potential penalties, and the service delivery

is expected to be better (Marques

and Berg 2011). Additionally, as many

forms of PPPs allow the financing of

the public infrastructure as off -budget

or off -balance-sheet, at least the public

perception is given that these models

avoid new debt (Bloomfield 2006; EPEC

2014). This fact may be more relevant

for the political level that decides

whether PPPs are principally an option

of service provision, less important for

the administration.

As for the administrative level, the

expectations regarding to the implementation

of PPPs may differ. Beyond the

expected benefits – which in the long

term also may enlarge the leeway of the

administration in the sense of Niskanen

(1971) – there are at least short-term

restrictions or inconveniences arising

from PPPs. The administrative level

has to cope with new (prospective) partners,

most likely new legal regulations

for tendering the PPP, and possibly the

public that has a stake in the respective

project. An increased workload or the

necessity of further training may be the

consequence – in particular for smaller

administrative bodies a challenge that

is not easy to manage. The implicit assumption

that the public partner may

have a homogeneous interest therefore

has to be questioned. This fact becomes

relevant in the context of corrupt behavior,

as the drawbacks coming from

PPPs may increase the single civil

servant’s impulse to be open towards

bribes and corruption.

In contrast, the private company

is driven by profit motives (Reeves

2008). In addition to maximizing its

profit in the specific projects at stake,

the private partner typically pursues

a long-term, strategic goal, too. By

committing to a specific PPP in a specific

country, the enterprise gains at

least indirect access to a market which

may not be open for full privatization

(yet). This investment, in turn, may be

a potential first-mover advantage in

the eventuality of a subsequent privatization

(provided, of course, that the

company has gained a reputation as

a dependable and fair partner during

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the PPP period). Moreover, experience

and expertise in one country as a PPP

partner may increase the likelihood of

winning future tenders for similar PPP

projects in other contexts, which is of

interest in particular for multinational

enterprises.

Furthermore, with the related concepts

of corporate social responsibility

(CSR) and stakeholder activism

becoming more and more relevant for

multinational companies (at least for

those which are head¬quartered in

Western-style democracies with free

media), in some special cases the decision

to enter into a PPP project may

not exclusively follow a short-term

profit maximization motive (narrowly

defined). It may rather be intended as a

signal of a high(er) degree of stakeholder

orientation to customers, the public,

the media, governments and NGOs

from all countries where the company

is doing business. In other words, under

such circumstances a PPP activity

may convince the public partner of the

company’s goodwill and may accordingly

influence it to consider the company

the government’s preferred partner in

future (case-by-case) decisions on upcoming

PPP projects or privatization

programs – thereby giving rise to another

first-mover advantage by raising

potential rivals’ costs of market entry.

ІІІ. Corruption

in Partnership Regimes

1. Corruption – Definition and

Main Variants

With a view to the broad range

of actions and measures that can be

classified as «corruption» – whether

in the scientific or the public debate

–, the phenomenon of corruption can

be captured in its entirety only by an

interdisciplinary approach (von Arnim

et al. 2006). Beyond the legal definition

of corruption, which differs amongst

countries, other approaches that may be

of interest here are political, socio-economic

or more philosophical perspectives

on this topic (see e.g. Caiden and

Caiden 1977). As the constituent factor

of corruption in our definition, the –

mostly clandestine – use of assigned

power for private gains clearly stands

out, whether by government officials

or other individuals (von Arnim et al.

2006). This fact is even more relevant

as – in the context of the economic theory

of new institutional economics– in

all cases of assigned power some kind

of principal-agent-relationship exists.

A principal, who delegates power, and

an agent, who wields that power, but

whose actions cannot be supervised by

the principal, characterize such a situation

in which corruption is likely to

occur. This is true even though not all

kinds of violations of obligations that

occur due to principal-agent-problems

can be characterized as corruption.

Following this definition, corruption

may occur in the private as well as

in the public sphere. As a multi-level

agency problem, it can also occur at

all levels of the state simultaneously

– i.e. between the voting population,

politicians and bureaucrats – and is

by no means restricted to the public

administration (Puwein et al. 2004).

The implicit assumption is that there

is a societal consent regarding the acceptable

set of actions, and a clear-cut

understanding of where misuse of authority

or assigned power starts (Caiden

and Caiden 1977).

This definition covers a broad range

of actions, independent from the question

if, or if not, the individual act of

corruption is liable to prosecution in a

specific context. This broad approach is

necessary as the legislation as well as

the general attitude towards corruption

differs substantially across countries:

while in most countries worldwide

bribery is illegal, prosecution schemes

differ, and so does the perception of

unethical behavior. Hence, even if a

specific act – e.g. the distortion of the

tendering process in favor of an enterprise

the public official may be linked

to – is socially accepted, it causes the

negative effects associated to corruption.

Accordingly, also non-criminal

actions as nepotism could be understood

as corruption in the sense of this study,

as long as they lead to unfavorable outcomes

in terms of inefficient allocation

of bids, inefficient service delivery

or increased cost levels for the public

sector.

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Moreover, corruption often can occur

as network corruption in the sense

that a relatively closed social network

benefits from the corrupt practice, not

only a single individual. Actions that –

directly or indirectly – improve one’s

position within the social network are

undertaken (von Arnim et al. 2006).

Here, often a time lag exists between the

corrupt practice and the benefit from it:

The investment occurs at t1, while the

return on investment (RoI) occurs in t1

or t2 or even later (Priddat 2005).

2. Are PPPs particularly corruption-

prone?

Within the last decades, a branch of

literature emerged which focuses both

theoretically and empirically on the origins

and consequences of corruption (for

an overview see Graf Lambsdorff 2006;

Mauro 1995; von Arnim et al. 2006). As

corruption mostly occurs «in the shadow»

– though not necessarily in the shadow

economy, but without being discovered

and statistically recorded –, a quantification

of corruption and its consequences

is not easy to perform (von Arnim et al.

2006). This is even more relevant with a

view to corruption within PPPs.

In general, corruption arises at the

interface of business and the political

sphere – exactly the point where PPPs

are located (Priddat 2005). Based on

insights from principal-agent theory

and contract theory the vulnerability

for corruption in PPPs can be grounded

on three characteristics: the very incomplete

and somewhat discretionarily

decided contract with high transaction

costs they are based on, the multi-level

characteristics of implementation and

execution, as well as the underlying

multi-step or life-cycle concept. This

vulnerability may realize in different

specific channels for bribery and

render them more corruption-prone

than other contractual agreements or

collaborations between the private and

the public sector (Hemming 2006; Iossa

and Martimort 2014; Klitgaard 2012).

Incentives as well as possibilities to

become corrupt are induced by these

characteristics, so our assumption. In

the following, we conceptualize the

channels through which corruption can

take place in the context of PPPs, and

outline some counter-strategies that

may help to insulate these cooperation

regimes against corruption.

Assuming that individuals have no

implicit preference towards more or

less corrupt behavior, their decision will

depend on the incentive in a specific

situation and the expected costs – including

transaction costs – and benefits

from their decision. Consequently, for

both sides – the briber and the bribee –

corruption can be modelled as a revenue

function. The underlying assumption is

that the private side has an incentive to

bribe the public servant (not vice versa).

While the decision to implement a

partnership with the private sector is a

political one (pre-tender decision), the

tendering and execution process itself

is guided by the administrative level

(ex ante as well as ex post to the project

execution). Hence, we can assume

that in most cases the receptor side for

corruption will be on the public side:

The political level may be the subject

of bribery in the pre-tendering phase,

with enterprises trying to influence politicians

to open up sectors for PPPs, or

more concretely, to turn a single project

into a PPP. The administrative level

will be the target whenever a private

enterprise strives for becoming part of

a newly established PPP, as the public

administration allocates the right (which

is often a monopoly) of serving the

market. The same applies to corruption

in the execution phase of the project

or after completion (in the context of

re-negotiations or contract renewal).

For the politician as well as public

servant, the decision to become corrupt

can be modelled similarly. The bureaucrat

is likely to accept bribes or other,

non-monetary benefits if the expected

benefit/revenue (that may be higher or

lower than the costs of corruption of the

private partner and may be subject to

discounting if the pay-off is in the future,

e.g. a position in the board of a private

company for a politician) are higher than

the expected penalty or opportunity costs

(dismissal or loss of pension) times the

probability of being caught.

For the briber, the private enterprise,

the revenue stems from the cash flow of

the project – may it be the direct pay29

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ment by the public sector, user fees, or

a mixed approach. The costs of the PPP

include not only the implementation or

service costs (depending on the PPP

type), but also transaction costs and

the costs of paying the bribe, as well as

additional costs from the discovery of

corruption (punishment costs, e.g. loss

of reputation or the penalty multiplied

by the probability of discovery). The incentive

for corruption is given when the

revenues outperform the costs. Hence,

corruption is likely when under corruption

the cash flow from the project is

higher or the implementation- or service

costs may be lower (e.g. due to reduced

quality standards, overpricing of the

users or underinvestment).

The revenue stream as well as the

costs related to corruption are endogeneous

to the respective project, even if

they may differ substantially amongst

projects, depending on the PPP-type,

the specific contract design as well as

the financial size of the project, while

the probability of being caught is exogeneous

to the specific project.

Table one summarizes the characteristics

of PPPs that may be relevant

in the context of corruption and are

directly related to the multi-level

characteristics of implementation and

execution, the somewhat discretionarily

decided incomplete contract they are

based on, as well as the inherent multi-

step or life-cycle concept.

Incomplete contracts

and transaction costs

PPPs typically emerge in a context

of incomplete information and uncertainty,

contracts will – necessarily – be

incomplete (Bud?us and Gr?b 2007;

Parker und Hartley 2005). The physical

nature of the network, uncertainty

regarding future use as well as the

likelihood of specific external «shocks»

remain unclear at the time the contract

is fixed. Even if contingent clauses can

be applied, their use imposes requirements

– possibly realized events have

to be anticipated, described and verified

– that are not easy to fulfil (Iossa and

Martimort 2014). All measures, undertaken

by one or both contract parties

to overcome that incompleteness «give

rise to correspondingly high transaction

costs» (Dudkin und V?lil? 2005). With

a view on the transaction cost theory,

developed by Coase (1937) and Williamson

(1975/1985), transactions – such as

the transfer of property rights – can

never be realized free of cost (Richter

and Furubotn 1999). Transaction costs

therefore are all costs which occur

in the context of contract formation,

monitoring or enforcement, including

information costs and the costs of

the creation of institutions necessary

for contract supervision (Blum et al.

2005). These costs, arising from the

incompleteness of the contract, increase

the total costs of the deal. They are of

Table 1

PPP Characteristics and Corruption

pre-level ex ante ex post

Subject Political level Administration Administration

Taks/

Decision

PPP or other forms

of provision (public only,

outsourcing etc.)

• PPP-Model

• Contract details

• Private partner

• Renegotiations?

• Application of penalty

clauses?

• Change of contract

contents

Channel for

corruption

• Discretion

• Lack of transparency

• Discretion

• Lack of transparency

• Information asymmetry

• Transaction costs

• Lack of transparency

• Contract incompleteness

• Information asymmetry

• Transaction costs

• Hold-up situation

Possible

consequences

• Market distortion

• Inefficient resource

allocation

• Space for inefficiencies

in later stages of the

PPP-project

• Dysfunctional

competition for the market

• Suboptimal choice of

PPP-type

• Choice of inefficient

partner/second-best

solution

• Overpricing of users

or the public sector

• Additional transaction

costs for the public sector

• Loss of service quality/

underperformance

Source: Author’s compilation

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specific importance when opportunistic

behavior – «the incomplete or distorted

disclosure of information, especially

the calculated effort to mislead, distort,

disguise, obfuscate or otherwise

confuse» (Williamson 1985) – is to be

expected, which also must be taken care

of in the contract (see e.g. Erlei et al.

2007). The exploitation of information

asymmetry can also be categorized as

opportunistic behavior – with the danger

of opportunism increasing with

asset specificity (Reeves 2008).

These costs occur at each stage of

the PPP; corruption can therefore be

helpful to reduce these costs – for the

private, but also for the public partner:

successful corruption creates a kind of

hold-up situation to the disadvantage

of the public partner, as – in the sense

of modern national states’ enabling

and guarantor role in the provision of

services – the public employee is tied

to the private enterprise. As a consequence,

and knowing that any service

interruption will result in additional

problems, the incentive to make concessions

can be assumed to be higher than

in other contractual arrangements. In

addition, through upstream-corruption

potential problems in the future can be

smoothened – a fact which also becomes

relevant if the tender process itself

was completed without corruption, as

for future projects, contract renewals

or re-negotiations the RoI may be high

enough. At the same time, also for the

public partner corruption may be useful

as – being tied together through

corruption – the public partner’s risk

of becoming a victim of later re-negotiations

may be lowered.

Multi-level characteristics

Even if many scientific studies tackle

the pre-level, the political decision in

favor of a PPP, or the level ex ante to

the implementation of the PPP, the

tender process itself, the post-tender

stage has been widely ignored so far, as

well as the potential problems arising

from the PPP-inherent multi-level characteristics

(Iossa and Martimort 2011).

At the first, the pre-decision level,

politicians decide to turn a specific

infrastructure project into a PPP. As

evidence demonstrates that in general

corruption may lead to misallocation of

resources, e.g. in favor of sectors with

a higher potential to be «bribe-generating

», it is likely that the same

effect may take place in the context of

PPPs (Liu and Mikesell 2014). From

the firm’s viewpoint, corruption in

this first stage of the PPP-process is

characterized by a high risk, while the

outcome remains insecure. Caused by

the multi-level characteristics of PPPs,

even if the respective political decision

has been (successfully) influenced in favor

of the PPP-alternative, there is no

certainty that the enterprise itself will

be the private partner in the project.

Nonetheless, corruption at this level

may be useful from the firm’s viewpoint

if the expected benefit is high enough

(in particular multi-step PPPs with a

large financial volume that include operation

and ownership may be affected

here, similar to experience from sheer

privatization projects, see e.g. Sclar

2000; Savas 2000).

As for all kinds of PPPs, the tender

process is of pivotal relevance, with

being quite similar to more general

forms of public procurement (and therefore

extensively covered by literature,

e.g. Sclar 2000; Savas 2000; Iossa and

Martimort 2011). As delineated above,

in the ex ante and ex post stage, the

administration is the decision-maker,

implementing and managing PPPs,

and consequently the second stage

with regards to corruption. Corrupt

behavior can take place at this stage

independently of previous corruption on

the political level, even if there may be

an amplifying effect: once an enterprise

paid bribes to turn a specific project

into a PPP, the misunderstanding of

«sunk costs» may lead to corruption at

this later stage.

In most countries, e.g. in the member

states of the EU, formal public

procurement law has to be applied before

a PPP can be established, similar

to other forms of contracting out. In

the European Union, several directives

specify the relevant marginal values for

application of tender processes in infrastructure

provision. Furthermore, the

single member states regulate the ten31

№ 7-8/2016

der and contracting procedure on their

own. Consequently, the legislation in

some member states may go beyond the

– already strict – European regulations.

Nonetheless, the general question, if

PPPs – independent of the design in

terms of control or majority – can be

implemented without a tender process

remains controversial (see e.g European

Court of Justice 2005 and 2009;

European Commission 2005; European

Parliament and Council of Europe 2004

and 2004a). While this fact diminishes

to a certain degree the implicit idea

of innovation in PPPs, which should

not be affected by a large number of

regulations, on first sight it may also

shield partnerships against corruption

(Bloomfield 2006). Per se there is no

chance to bypass existing public procurement

laws with the implementation

of a PPP, at least in more developed

countries. This also is the case for unsolicited

offers by private companies

without a prior tender process (see for

details Hodges und Dellacha 2007). Accordingly,

the selection of the private

partner is most of the time the endpoint

of a two-tier decision-making process.

Within this process, a competition for

the market, private companies make

their bids to win the contract.

For all enterprises that are involved

in public procurement contracts in general,

this stage of the decision-making

process is of pivotal interest, as it is

characterized by both – high risk and

substantial cost drivers – while the

outcome still remains insecure. The

search for tender information, specific

information about the planned project,

the preparation of the offer itself, and

the provision of sufficient proofs of

suitability are relevant for success in

the bidding process, but costly. Payments

for insider information or an

inclusion in the list of pre-qualified

bidders may pay off here, as well as to

influence the structure of the bidding

specifications so that the enterprise is

the only qualified supplier (Cobarzan

and Hamlin 2005). The private enterprise

also may influence the PPP-model

chose as well as contracting details –

both aspects that are relevant for the

long-term RoI as well as for the service

quality and quantity and therewith the

public interest in the project. As for

the public sector, the specification of

the services in question, the contract

outline as well as the examination of

and the decision on the biddings are of

specific relevance. Additionally, and

before the tender process can be started,

a project-specific suitability test has to

be undertaken whether the project can

be efficiently managed as a PPP.

As all these steps give rise to high

transaction costs, corruption within

this stage therefore seems to be especially

worthwhile for both parties,

reducing their costs, and may thus

be more likely to occur than during

the later stages. Discretion is a key to

corruption in this context as well, in

particular if accountability is limited

– e.g. due to limited transparency –

and monopolies are affected (Klitgaard

2012). This is all the more true as the

detection probability can be valued as

relatively low, as the contract typically

is kept confidential, and little transparency

exist on the contingencies that

trigger monetary compensations to the

contractor or even on the amounts paid»

(Ioassa and Martimort 2014) – neither

ex ante nor ex post. Hence, only the

two contract parties have the complete

information on and overview over the

contract. This fact increases the incentive

and therewith opens the door for

the private enterprise to manipulate the

bidding process by corruption, as it is

unlikely that corrupt behavior will be

detected by a third party external to

the deal. Transparency, a very relevant

instrument of control – for the public

as well as the losing bidder – therefore

is missing. Accordingly, the options for

the latter to take legal action are limited.

Another problem in this context is

the fact that bidding cartels are not the

exception, in particular in those infrastructures

where an oligopolistic market

structure exists, so that inefficient

allocation may lead to monopoly rents

for the winning enterprise, increasing

the RoI and therewith the incentive

for corruption (Andres, Azumendi, and

Guasch 2008).

In the execution phase of the PPP,

ex post to contracting, particularly a

32

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ТЕОРІЯ

long contract duration can be relevant

with regards to the likelihood of corruption.

Enterprises may underinvest

or under-maintain, the users may be

overcharged or provided with low service

quality, and cover their underperformance

with bribes (Estache 2014).

This may be in particular relevant

with a view to contract re-negotiations,

which occur in most cases (Marques and

Berg 2011). Corruption in this phase

may cover the underperformance, so

that a successful contract renewal is

possible – the investment in corruption

will ceteris paribus yield a high RoI

as the cash flow from the project can

be expected to be supra-normal if the

conditions of the private firm will be

accepted by the public partner.

Life-cycle approach

The life-cycle approach contributes

in two ways to the increased vulnerability

of corruption: one important strand

of incentives results in the fact that

the different value-added steps included

in a PPP will result in high project

volumes, so that the direct costs of corruption

are likely to be lower than the

expected return on investment (RoI). At

the same time, in particular with a view

to the long contract period and to the

fact that most PPP contracts have to be

renewed after the first contract period

has ended, the investment in corruption

will ceteris paribus yield a high RoI,

as the cash flow from the project can

be expected to be supranormal if the

conditions of the private firm will be accepted

by the public partner (Klitgaard

2012; Marques and Berg 2011). Hence,

following the decision logic delineated

above, for the private enterprise the

incentive for corruption is high.

Moreover, the longer a cooperation

lasts, the higher the risk of reciprocal

personal advantage, as mutual trust

and understanding grow over time

(Bannenberg and Schaupensteiner 2004;

Sack 2004). This fact is of relevance

as reputation and trust are of pivotal

importance when it comes to the reduction

of transaction costs of corruption

(Parker und Hartley 2005). The incentive

to behave opportunistically will be

lower over time, as the gains from trust

will be increasing successively (Erlei,

Leschke, and Sauerland 2007). The

longer the contract lasts, the higher the

probability that the benefits from trust

will exceed the benefits from opportunistic

behavior; reputation and trust

become a kind of social capital, which

accumulates with further use; Parker

and Hartley 2005). Therefore, the risk

of treason decreases with the contractual

period that has already past. Accordingly,

the likelihood of corruption

increases in long-term cooperations, as

the individuals’ risk decreases – knowing

the partner better, being bound by

trust increases the likelihood to give/

take the bribe. In this context, in particular

corruption that is designed to

assure the successful re-contracting

is of relevance: The payment occurs

during the first contract period, while

the benefits materialize in the second

period. Additionally, corruption to enforce

re-negotiations of the contract in

favor of the private enterprise during

the contract period are to be expected

at this point, e.g. with a view to an

increase of tariff rates or a decrease

of quality standards. This may especially

be the case in markets which are

characterized by intense competition,

where the initial bidding has to be low

in terms of fees or tariffs.

3. Implications of corruption in

PPPs

Based on the gateways of corruption

delineated above, corruption may

restrict the successful use of PPPs as

an instrument in service delivery in

several ways. First, the overall efficiency

of the project is on the trail at

least once corruption takes place: the

alleged increase in cost efficiency of

PPPs – per se questionable, for being

nearly impossible to assess ex ante –,

compared to traditional public provision,

must not be offset by the costs of

corruption (Flyvbjerg, Skamris Holm

and Buhl 2002). As delineated above,

the threat of corruption may increase

transaction costs, or corruption actually

taking place decreases the value for

money of the project. Hence, corruption

lowers the likelihood that a specific

project can be run more efficiently as a

PPP than via public procurement. This

33

№ 7-8/2016

would not only diminish the expected

benefits from PPPs, but can also lead

to increased costs compared with the

status quo ante.

Second, and closely related to the

first point, competition may be distorted:

if the private enterprise is able

to suppress the market mechanism

through successful corruption, it becomes

a price maker instead of being

a price taker, relatively similar to the

classic monopoly situation, even if it

could not exist in a competitive environment

(Priddat 2005). Hence, corruption

can render an inefficient bidder the

successful, winning bidder – a special

form of adverse selection. Depending

on the details of the PPP design, this

inefficiency may result not only in

additional costs for the public partner

(when the payment is fixed) or non-optimal

prices for the consumers, e.g. in

all concession models, but also may lead

to ineffective service provision.

Lastly, corruption comes to the disadvantage

of «weak interest» in the

public sector (Sack 2004): as through

PPPs the existing principal-agent problems

can be modified in the sense that

– due to asymmetric information and

fiscal leeway – political or public interest

becomes less important than the

business interests of the oligopolistic

market players. Corrupt PPP regimes

therefore act as a kind of monopolization

of semi-open market situations

(Priddat 2005). This problem becomes

even more obvious because merely the

public partner is bound by public law

and political rationales, which do not

apply to the private enterprise. Accountability

in the traditional sense is

not given in these cases; again, disadvantages

for the public interest may be

the result.

IV. Conclusion

PPPs became an important instrument

of the public sector to finance and

manage much-needed infrastructure

and services. Independent of the potential

gains out of these cooperations,

specific challenges may arise that may

compromise not only the long-term success

of these partnerships, but also may

make them less desirable – in terms of

efficiency and effectiveness – compared

to the status quo ante. Corruption may

be amongst all the most challenging,

but only marginally noted factors in

this context.

Several factors can be identified that

help to control corruption – based on

Becker and Stigler (1974), the proper

combination of monitoring and punishments.

They tackle the exogeneous

dimension, increasing the likelihood

of exposure, not the project-inherent

dimension of direct corruption costs

or revenues. Increased transparency,

regardless of whether it is enforced due

to changes in the legal framework, or

due to public attention, is one crucial

issue in this context. This applies to

both levels, the political as well as the

administrative level. Decreasing the

«discretion of contracting authorities

by making greater use of centrally

determined guidelines on contracts»

(Iossa and Martimort 2014) also may

reduce corruption at the ex ante and

ex post level, as well as audit based on

performance, specific whistle-blower

programs or job rotations and the broad

use of the «four eyes principle».

Quite similar effects can be induced

by an increase of the costs of corruption

through higher penalties (for public

as well as private actors) if a corrupt

practice is discovered – both with respect

to penalties and imprisonment.

Also payments schemes for the public

administration matter in this context:

If life-long career systems in the public

sector are no longer existent or obtaining

lifelong employment becomes

unlikely for the individual in a specific

position, the risk of corruption will be

substantially higher compared to the

status quo ante.

Overall, the specific vulnerability for

corruption can be seen as inherent to

the PPP system, and is therefore not

easy to erase. The proposed measures to

reduce the risk of corruption in the context

of PPP implementation therefore

can never eliminate corruption totally,

but can increase the costs of corruption

and/or lower its benefits; they might

therefore reduce it in the long run,

starting by changing the parameters of

decision-making of individuals.

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ТЕОРІЯ

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