Universite´ De Paris Sud XI Allocation of Property Rights and Incomplete Contracting The Economics of Local Public Services These` Pour Obtenir le Doctorat en Sciences Economiques´ pr´esent´eeet soutenue par Claudine Desrieux le 14 mars 2008 Directeur de Recherche M. le Professeur Stephane´ Saussier (Universit´ede Paris Sud XI) Rapporteurs Mme. le Professeur Elisabetta Iossa (Brunel University, United Kingdom) M. le Professeur Bruno Deffains (Universit´ede Paris X Nanterre) Suffragants M. le Professeur Dominique Demougin (European Business School, International University Schloss Reichartshausen, Germany) M. le Professeur Jean-Michel Glachant (Universit´ede Paris Sud XI) L’Universit´ede Paris Sud XI n’entend donner aucune approbation aux opinions ´emisesdans les th`eses;ces opinions doivent ˆetre consid´er´eescomme propres `aleur auteurs. CONTENTS Acknowledgement 1 Abstract 4 General Introduction 8 I Property rights and Management of public services 20 1 Incomplete contracts theory (ICT) and the study of public services 22 1.1 Introduction ............................... 22 1.2 A rigorous theoretical framework to analyze public services ..... 27 1.2.1 ICT as a theory of the firm .................. 27 1.2.2 ICT and organization of local public services ......... 34 1.3 The seminal work of Hart, Shleifer, Vishny [1997] .......... 45 1.3.1 The framework ......................... 45 1.3.2 Equilibria ............................ 48 1.3.3 Analysis of the optimal ownership structures ........ 51 1.3.4 Illustrations ........................... 55 1.4 Extensions and unanswered questions ................. 58 1.4.1 Extensions of this work ..................... 58 1.4.2 Unanswered questions ..................... 62 1.5 Conclusion of chapter 1 ......................... 69 i 2 Public-private partnerships and the split of property rights 73 2.1 Introduction ............................... 73 2.2 The various types of public-private partnerships ........... 78 2.2.1 Ownership and contracts in the GHM approach ....... 79 2.2.2 Main PPP schemes ....................... 81 2.2.3 Theoretical consequences .................... 86 2.3 Owner or Holder? ........................... 90 2.3.1 Equilibria in public-private arrangements ........... 94 2.3.2 Analysis of the optimal ownership structures ........ 97 2.3.3 Applications ........................... 101 2.4 Conclusion of chapter 2 ......................... 104 II Legal and informal practices in public-private partnerships109 3 The legal extra powers of public authorities as co-contractor 111 3.1 Introduction ............................... 111 3.2 Contracts and legal rights for public authorities ........... 116 3.2.1 French law and public contracting ............... 117 3.2.2 Theoretical consequences .................... 119 3.3 Incomplete contracts and Rights of unilateral intervention ..... 123 3.3.1 Equilibrium under private provision with specific rights for public authority ......................... 123 3.3.2 Analysis of the results ..................... 124 3.4 Discussion ................................ 130 3.4.1 Rights of unilateral intervention and bargaining games ... 131 3.4.2 Equilibrium under “fair” unilateral modification ....... 134 3.4.3 Equilibrium under unfair use of unilateral rights ....... 136 3.5 Conclusion of chapter 3 ......................... 138 4 Horizontal Integration and Relational contracting 140 4.1 Introduction ............................... 140 4.2 The theoretical model ......................... 145 4.2.1 The general framework ..................... 145 4.2.2 The first best .......................... 148 ii 4.2.3 The one-shot game ....................... 149 4.3 The repeated game framework ..................... 152 4.3.1 Horizontal disintegration: A different operator for each service154 4.3.2 Horizontal integration: A same private operator ....... 157 4.3.3 Cost comparison and proposition ............... 159 4.4 An empirical analysis of horizontal concentration in the French wa- ter sector ................................ 160 4.4.1 Putting the Model to the test ................. 160 4.4.2 The Data ............................ 162 4.4.3 Empirical methodology ..................... 165 4.4.4 Estimation results ....................... 168 4.4.5 Alternative explanation ..................... 172 4.5 Conclusion of chapter 4 ......................... 176 General Conclusion 179 References 186 List of Figures 195 1 ACKNOWLEDGEMENT The preparation of a Ph.D. dissertation is an arduous task. Without the help and encouragement of numerous people around me, it would have been impossible for me to accomplish this work. My utmost gratitude goes to them. First and foremost, I thank my PhD supervisor, Professor St´ephane Saussier, for his guidance, support and comments. I am also very grateful to Professor Pierre Garrouste, Professor Jean-Michel Glachant, Professor Claude M´enard, Fr´ed´eric Marty, Claude Parthenay, Yannick Perez, Em- manuel Raynaud, Carine Staropoli, and Anne Yvrande-Billon for generously shar- ing valuable comments, knowledge and experience with me. Other colleagues and fellow students at the ADIS and ATOM research centers have also offered many enlightening thoughts and discussions that have proved to be highly useful to my work. They include Miguel Amaral, Laure Athias, Jean Beuve, David Cayla, Es- hien Chong, Julie De Brux, Olivier Desbiey, Milena Gradeva, Freddy Huet, Alexan- dra Le Chaffotec, Aude Le Lannier, Marie-Joelle Kodjovi, Jean–Michel Oudot, Annie Royer, Roxana Saplacan, and Jean-Fran¸cois Sattin. I would like to thank them for their time and effort, and for the moral support that they have provided to me throughout the years. It has been a great pleasure to work with them. I would like to mention a special thanks to Eshien Chong and Milena Gradeva, es- pecially for their support during the summer 2007. I also benefit from stimulating discussions at AEGIS seminars, thanks to Herv´eDumez and Alain Jeunemaitre. Marie-C´eline Loubaresse and Laetitia Vincent have also provided me with relevant observations. 2 My gratitude goes to the Conseil National de l’Information Statistiques (CNIS) and the Service Central des Enquˆeteset Etudes´ Statistiques (SCEES) of the Min- istry of Health, and Institut Fran¸cais de l’Environnement (IFEN) for allowing me to use some data on water sector (Enquˆetesur les collectivit´est´erritoriales et l’environnement - volet eau et assainissement). I am also grateful to University of Paris Sud XI for the research allocation that has allowed me to finance my work, and to University of Paris I and University of Paris II for a position as a teaching assistant. Last, but not least, I would like to thank my family for its unconditional support. I have also a special thought for my friends, whom I met at ENS Cachan, and with whom I have shared work experiences and far more, as well as those I know from my younger age, and those who have joined up with me later on. 3 ABSTRACT This dissertation attempts to study organizational structures of local public ser- vices. Public authorities may generally provide many of these services in-house or may choose to contract them out. Such a trade-off is a complex decision, with many social and economic consequences. This work aims to provide decision-makers with some propositions to better apprehend contractual tools allowing private firms to be involved in the management of local public services. The perspective that is adopted is that of the incomplete contracts (or “prop- erty rights theory”) as developed by Grossman and Hart [1986], Hart and Moore [1990], and Hart [1995] (and called “GHM approach” hereafter). It offers a use- ful and rigorous theoretical framework to evaluate contractual arrangements, and their consequences on non-contractible investments. This approach may be ap- plied to the management of public services, as the seminal paper of Hart, Shleifer, and Vishny [1997] shows. Yet, some refinements seem necessary to better un- derstand what makes contracts of public-private partnerships different from other types of cooperation. More precisely, three features of these partnerships draw our attention, and suggest some refinements of the GHM approach. First, while the property rights literature has focused on the trade-off between public and private provision, observations show a large continuum of contractual arrangements be- tween full public management and full privatization. Their evaluation calls for a 4 revision of the theoretical notion of “residual control rights” associated with owner- ship. Results of this first refinement show that there is always one type of contract with the private sector that allows to equal or outperform public provision. Second, public-private partnerships are “legal tools” mainly shaped by the legal environment in which they are executed. For instance, in France, the legal frame- work grants public authorities with some special rights to unilaterally modify or even cancel contracts, in order to protect public interest. It is found in this dis- sertation that these specific rights are not neutral in the contractual performance. They induce new types of renegotiations, and may change bargaining conditions between partners, compared to what is generally admitted in the GHM approach. Effects of these legal rules on contractual efficiency depends on the anticipated use of these rights. Last, observations of public-private contracts also show that public authorities tend to concentrate several services in the hands of one single private operator, which seems paradoxical as