An Analysis of Government Loan Guarantee and Direct Investment in Public-Private Partnerships

Abstract

This paper compares two forms of governmental support programmes: loan guarantee and direct investment in public-private partnerships (PPPs). Under the loan guarantee programme, the government supports the project implementation by providing financial guarantees to enhance the project creditworthiness. Under the direct investment programme, the government participates in the project by investing a given amount of capital in return of shares in the project. We find that loan guarantees are more effective in reducing the borrowing rate of the project. In an informational asymmetry environment, where the government knows less about the project quality than private partners, in other words, subject to the so called plum problem, it will be better for the project sponsors to obtain loan guarantee from the government, unless they are willing to give up more control over the project. We show how the portion of shares granted to the government can be a bargaining tool and can mitigate the information asymmetry in structuring PPPs.