Download COST-BENEFIT ANALYSIS AND INCENTIVES IN EVALUATION

COST-BENEFIT ANALYSIS
AND INCENTIVES IN
EVALUATION: PUBLICPRIVATE PARTNERSHIPS
Open Days 2006
Brussels 9-12 October 2006
Professor Massimo Florio
University of Milan
RESEARCH ON CBA AND
INCENTIVES
“Good project appraisal is done by people with
their own incentives, within organizations that
wittingly or not set these incentives.Both
environments of project appraisal, the
intellectual and political-organizational, are
keys to the quality of selection overall. This
needs to be most seriously considered by
those who manage and create this
environment” (Little and Mirrlees, 1994)
CBA THEORY IN A MULTIGOVERNMENT SETTING
Six type of agents:
• Individuals: consumers,workers,tax-payers,
private shareholders
• Private firms: profit maximizers
• Public firms: fully under government’s control
• Regional planners/evaluators
• National planners/evaluators
• The supra-national planner/evaluator
What planners do?
• EC fixes some rules of the game and
allocated funds
• Regions and MS fix production plans
• Select policies (not projects)
• Given their constraints solve a planning
problem in terms of a set of shadow prices
• Hire ex-ante and ex-post evaluators
• Co-finance selected projects, assign
performance bonuses
What evaluators do?
• Gather project data
• Make forecasts
• Use shadow prices (they must be price
taker!) as given by the planner
• Check is the project passes the CBA
test: positive shadow profits
• Suggest project approval to the planner
Many players
• By definition there are three planning
problems (European, national, regional)
• Then there are then three sets of
shadow prices, and three evaluations
• The planning problem is nested
because approval and co-financing
needs consensus of the three players
How bottom-up evaluation
works
EC
Regional
National
Each evaluator selects profitable projects:intersection gets approval
Information shared
• If all players share information, regional
evaluators can use other planner’s shadow
prices to find the intersection
• Typically a small set of shadow prices is
needed: SDR, SWR, major types of tangibles
inputs and outputs, some intangibles (value
of time, statistical life, environment
externalities), welfare weights
• Under PPP information is not shared
Information: uncomplete and
asymmetric
• Planners are uncertain about empirical
shadow prices, how much do they need to
spend in generating the right signals?
• Evaluators know less than the private firms’
managers, but more than the planners:how
much evaluation effort is needed?
• Policy-makers and managers may wish to
capture evaluators: what is the prize of
honesty in evaluation?
A SIMPLE EXAMPLE OF
INCENTIVE MECHANISM FOR CBA
STEP 1
- The EU planner signals that the financial discount rate
FDR is 4% and the economic discount rate SDR is
4% as well. Other shadow prices are computed and
disseminated by national/regional planners. A budget
is allocated for acceptable regional infrastructure
projects .
- The regional planner appoints an ex ante evaluator ,
establishes a benchmark ERR* in excess of the EU
SDR, and asks management teams to offer projects
STEP 2
- The ex - ante evaluator says that:
-
one project has an expected (i.e. risk adjusted)
financial rate of return of real 2% based on costs
declared by the proponent (FRR/C), hence the
financial FNPV is negative
-
the expected economic rate of return EERR is 8%,
hence the economic ENPV is positive, using the EU
shadow prices (and to simplify, the test is passed at
regional shadow prices as well)
STEP 3
-
-
-
The regional planner offers a co-financing grant in two parts: a
funding gap part plus a linear incentive, if the EERR exceeds a
sector/regional benchmark e.g. ERR* =6%
The funding gap element is a fixed share of the net present
value of total costs, for example 80%.
The regional planner promises to pay an economic
performance bonus to the projects equal to 50% of the
difference between using a 4% EFRR and 8% EFRR.
The total grant is committed to be : 0.8 FNPV(4%)+ 0.5*0.8
(FNPV(8%) - FNPV(4%))= 0.4 FNPV(4%)+ 0.4 (FNPV8%), i.e. a
weighted sum of the eligible net costs, using the expected
financial and economic rates of return
Payment is in two parts: first the 0.8 FNPV(4%) is disbursed.
The incentive element is set aside.
STEP 4
• The contract is assigned. Operations start.
• Some time later an independent ex-post evaluator is
sent by the planner, and a re-estimated economic
rate of return RERR is computed.
• If the RERR>EERR >ERR*>SDR the performance
bonus is paid. If the ERR*<REER <EERR the bonus
is decreased. If REER<ERR* the bonus is cancelled.
In my example, if the RERR is below 6% the
performance bonus is cancelled.
• The bonus is co-financed by the EU funds and
shared by the regional planner and the project team
in some pre-established way:social profit/risk
sharing.
ADVANTAGES OF THE INCENTIVE
BASED MECHANISM
-
There is a performance bonus for socially deserving projects,
and the incentive to manipulate financial and economic project
analysis go in opposite directions
- Lack of realism in ex-ante evaluation incurs in a penalty,
because the economic performance bonus will be decreased
ex-post
- If the bonus is shared between the management team and the
regional planner, the incentive works for both players. The ex
ante evaluator gets a reputation bonus ( or penalty) for realism
(or for optimism bias)
- If the ex-post evaluator is a rating agency on behalf of the EU
there will be a more transparent learning process on
regional/national/sector projects success and failures.
CONCLUSIONS
- CBA should be the language of a common learning
mechanism. Planners should adopt policies, offer shadow
prices and hire ex-ante evaluators. Evaluators must act
as shadow price takers.
- Ex ante evaluators, regional planners, project team
should be given financial incentives to out-perform
economic benchmarks, and independent ex-post
evaluators, on behalf of the EU, should rate projects and
observe success and failures.
- Research/experiments are needed on how to agree
shadow price rules among players, and on incentive
mechanism design.