An investigation of incentive conflicts in the privatization of highly specific fixed infrastructure assets

Abstract

Inefficient industrial policies in the 1970’s led to the growth of privatization since the late 1970’s. Apart from the general trend of privatization worldwide, budgetary distress (1999-2003) after the Asian Financial Crisis (1997-8) obliged the Hong Kong government to adopt extensive privatization of public assets and services to increase income and reduce expenditure, including privatizing the construction, ownership and management of infrastructure projects. However, obstacles to efficient privatization abound, and it is suggested that incentive conflicts in privatizations may result in poorly performing or even failed transactions. Following a literature review, it is suggested that inefficient privatization seem to be present in complex and highly asset specific projects. The review suggests that asset specificity could also be an obstacle to efficient transactions. In project finance, however, it has been shown that asset specificity could be used strategically to manage agency incentive conflicts. It is thus argued that highly specific fixed assets privatization transactions may be incentive inefficient if incentive conflicts are unchecked. Since asset specificity has been used particularly in the project finance field to manage agency incentive conflicts, this study investigates the effect of high asset specificity in facilitating incentive efficient privatization of highly specific fixed infrastructure assets. The proposition that high asset specificity contributes significantly to incentive efficient privatization of fixed infrastructure assets is examined using the case study methodology. Incentive efficiency is taken to mean clear identification of incentive conflicts, clear measures taken to manage the conflicts, and clear measures taken to “minimize” costs incurred in managing such conflicts. A fourth concept, a transaction’s ’internal coherence’ is a subjective consideration of the mutually reinforcing functioning of these measures whilst drawing on asset specificity for additional effectiveness. An exploratory case study, the Western Harbour Crossing (WHC) Build Operate Transfer privatization, a highly specific cross harbour tunnel in Hong Kong, was analyzed. Evidence was sought through desk research of published secondary case material, aimed at confirming or otherwise the proposition. Three major sources of information, namely the concession agreement and allocation of property rights, corporate structure and financing and operational matters, were considered, following a structured transaction analysis framework. Incentive conflicts and corresponding management mechanisms are pointed out, and it is discovered that asset specificity has salient effects on the management of incentive conflicts in WHC. Since asset specificity was used strategically in the design of transaction governance mechanisms, asset specificity contributed substantially to enforce property rights and monitor incentive conflicts. Furthermore, the three concepts of incentive efficiency seem well coordinated. Thus it was argued that transaction governance in WHC was internally coherent. The presence of the four concepts of incentive efficiency was considered convincing evidence to conclude that high asset specificity contributes significantly to incentive efficient privatization of fixed infrastructure assets.