The Financial Engineering of Infrastructure Privatization

Abstract

Problem, research strategy, and findings: Leasing government infrastructure to private investors has been proposed as a practical way to increase both public revenue and investment in aging facilities, yet questions remain regarding lease value. In particular, some recent private auction bids surpassed government's lease estimates for U.S. roads and parking systems by hundreds of millions of dollars. We argue such discrepancies are largely explained by the use of structured finance or financial engineering techniques; these lower capital costs and maximize quick investor payouts, yet are often ignored in lease agreements because governments do not understand them. Our approach models the separate effect of several deal parameters on the investment return of a hypothetical tolled facility. We find even modest financial engineering (such as interest rate derivatives and swaps, deferred payment sweeps, or mark-to-market accounting practices) increases the current value of future facility revenues far more than changes in lease length, tolls, or operating costs. The public sector undercharges for its infrastructure when it ignores how private investors package and assess future revenue. Takeaway for practice: When leasing public facilities, governments would be smart to better understand potential investors’ capital structure and financial engineering strategies. Doing so avoids leaving money on the table; it also reduces the risks of future underperforming assets. Research support: None.