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Public-Sector Decision Making for Public-Private Partnerships (2009)

Chapter: Chapter Three - Public Private Partnerships Decision-Making Topics

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Suggested Citation:"Chapter Three - Public Private Partnerships Decision-Making Topics." National Academies of Sciences, Engineering, and Medicine. 2009. Public-Sector Decision Making for Public-Private Partnerships. Washington, DC: The National Academies Press. doi: 10.17226/13901.
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Suggested Citation:"Chapter Three - Public Private Partnerships Decision-Making Topics." National Academies of Sciences, Engineering, and Medicine. 2009. Public-Sector Decision Making for Public-Private Partnerships. Washington, DC: The National Academies Press. doi: 10.17226/13901.
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Suggested Citation:"Chapter Three - Public Private Partnerships Decision-Making Topics." National Academies of Sciences, Engineering, and Medicine. 2009. Public-Sector Decision Making for Public-Private Partnerships. Washington, DC: The National Academies Press. doi: 10.17226/13901.
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Suggested Citation:"Chapter Three - Public Private Partnerships Decision-Making Topics." National Academies of Sciences, Engineering, and Medicine. 2009. Public-Sector Decision Making for Public-Private Partnerships. Washington, DC: The National Academies Press. doi: 10.17226/13901.
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Suggested Citation:"Chapter Three - Public Private Partnerships Decision-Making Topics." National Academies of Sciences, Engineering, and Medicine. 2009. Public-Sector Decision Making for Public-Private Partnerships. Washington, DC: The National Academies Press. doi: 10.17226/13901.
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Suggested Citation:"Chapter Three - Public Private Partnerships Decision-Making Topics." National Academies of Sciences, Engineering, and Medicine. 2009. Public-Sector Decision Making for Public-Private Partnerships. Washington, DC: The National Academies Press. doi: 10.17226/13901.
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Suggested Citation:"Chapter Three - Public Private Partnerships Decision-Making Topics." National Academies of Sciences, Engineering, and Medicine. 2009. Public-Sector Decision Making for Public-Private Partnerships. Washington, DC: The National Academies Press. doi: 10.17226/13901.
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Suggested Citation:"Chapter Three - Public Private Partnerships Decision-Making Topics." National Academies of Sciences, Engineering, and Medicine. 2009. Public-Sector Decision Making for Public-Private Partnerships. Washington, DC: The National Academies Press. doi: 10.17226/13901.
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Suggested Citation:"Chapter Three - Public Private Partnerships Decision-Making Topics." National Academies of Sciences, Engineering, and Medicine. 2009. Public-Sector Decision Making for Public-Private Partnerships. Washington, DC: The National Academies Press. doi: 10.17226/13901.
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Suggested Citation:"Chapter Three - Public Private Partnerships Decision-Making Topics." National Academies of Sciences, Engineering, and Medicine. 2009. Public-Sector Decision Making for Public-Private Partnerships. Washington, DC: The National Academies Press. doi: 10.17226/13901.
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Suggested Citation:"Chapter Three - Public Private Partnerships Decision-Making Topics." National Academies of Sciences, Engineering, and Medicine. 2009. Public-Sector Decision Making for Public-Private Partnerships. Washington, DC: The National Academies Press. doi: 10.17226/13901.
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Suggested Citation:"Chapter Three - Public Private Partnerships Decision-Making Topics." National Academies of Sciences, Engineering, and Medicine. 2009. Public-Sector Decision Making for Public-Private Partnerships. Washington, DC: The National Academies Press. doi: 10.17226/13901.
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Suggested Citation:"Chapter Three - Public Private Partnerships Decision-Making Topics." National Academies of Sciences, Engineering, and Medicine. 2009. Public-Sector Decision Making for Public-Private Partnerships. Washington, DC: The National Academies Press. doi: 10.17226/13901.
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Suggested Citation:"Chapter Three - Public Private Partnerships Decision-Making Topics." National Academies of Sciences, Engineering, and Medicine. 2009. Public-Sector Decision Making for Public-Private Partnerships. Washington, DC: The National Academies Press. doi: 10.17226/13901.
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Suggested Citation:"Chapter Three - Public Private Partnerships Decision-Making Topics." National Academies of Sciences, Engineering, and Medicine. 2009. Public-Sector Decision Making for Public-Private Partnerships. Washington, DC: The National Academies Press. doi: 10.17226/13901.
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Suggested Citation:"Chapter Three - Public Private Partnerships Decision-Making Topics." National Academies of Sciences, Engineering, and Medicine. 2009. Public-Sector Decision Making for Public-Private Partnerships. Washington, DC: The National Academies Press. doi: 10.17226/13901.
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Suggested Citation:"Chapter Three - Public Private Partnerships Decision-Making Topics." National Academies of Sciences, Engineering, and Medicine. 2009. Public-Sector Decision Making for Public-Private Partnerships. Washington, DC: The National Academies Press. doi: 10.17226/13901.
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Suggested Citation:"Chapter Three - Public Private Partnerships Decision-Making Topics." National Academies of Sciences, Engineering, and Medicine. 2009. Public-Sector Decision Making for Public-Private Partnerships. Washington, DC: The National Academies Press. doi: 10.17226/13901.
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Suggested Citation:"Chapter Three - Public Private Partnerships Decision-Making Topics." National Academies of Sciences, Engineering, and Medicine. 2009. Public-Sector Decision Making for Public-Private Partnerships. Washington, DC: The National Academies Press. doi: 10.17226/13901.
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Suggested Citation:"Chapter Three - Public Private Partnerships Decision-Making Topics." National Academies of Sciences, Engineering, and Medicine. 2009. Public-Sector Decision Making for Public-Private Partnerships. Washington, DC: The National Academies Press. doi: 10.17226/13901.
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Suggested Citation:"Chapter Three - Public Private Partnerships Decision-Making Topics." National Academies of Sciences, Engineering, and Medicine. 2009. Public-Sector Decision Making for Public-Private Partnerships. Washington, DC: The National Academies Press. doi: 10.17226/13901.
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Suggested Citation:"Chapter Three - Public Private Partnerships Decision-Making Topics." National Academies of Sciences, Engineering, and Medicine. 2009. Public-Sector Decision Making for Public-Private Partnerships. Washington, DC: The National Academies Press. doi: 10.17226/13901.
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Suggested Citation:"Chapter Three - Public Private Partnerships Decision-Making Topics." National Academies of Sciences, Engineering, and Medicine. 2009. Public-Sector Decision Making for Public-Private Partnerships. Washington, DC: The National Academies Press. doi: 10.17226/13901.
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Suggested Citation:"Chapter Three - Public Private Partnerships Decision-Making Topics." National Academies of Sciences, Engineering, and Medicine. 2009. Public-Sector Decision Making for Public-Private Partnerships. Washington, DC: The National Academies Press. doi: 10.17226/13901.
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Suggested Citation:"Chapter Three - Public Private Partnerships Decision-Making Topics." National Academies of Sciences, Engineering, and Medicine. 2009. Public-Sector Decision Making for Public-Private Partnerships. Washington, DC: The National Academies Press. doi: 10.17226/13901.
×
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Suggested Citation:"Chapter Three - Public Private Partnerships Decision-Making Topics." National Academies of Sciences, Engineering, and Medicine. 2009. Public-Sector Decision Making for Public-Private Partnerships. Washington, DC: The National Academies Press. doi: 10.17226/13901.
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Suggested Citation:"Chapter Three - Public Private Partnerships Decision-Making Topics." National Academies of Sciences, Engineering, and Medicine. 2009. Public-Sector Decision Making for Public-Private Partnerships. Washington, DC: The National Academies Press. doi: 10.17226/13901.
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Suggested Citation:"Chapter Three - Public Private Partnerships Decision-Making Topics." National Academies of Sciences, Engineering, and Medicine. 2009. Public-Sector Decision Making for Public-Private Partnerships. Washington, DC: The National Academies Press. doi: 10.17226/13901.
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11 PPP projects raise a variety of concerns as they move from concept through project delivery. These concerns range from the initial decision to use a PPP procurement/delivery mech- anism through specifics of who has control over toll setting (where there are tolls involved), how risks and revenue are shared, and how the complexities of agreements can be com- municated to the public and decision makers. This synthesis has been organized into the following topical areas: • Project selection and delivery: – Criteria for deciding whether to use a PPP approach; – Unsolicited proposals and the transportation plan- ning process; – Roles of public and private sectors, risk allocation, and rates of return; – PPP valuation tools; and – Bonding, bonding capacity, letters of credit, and ini- tial construction warranties. • Transparency: – Transparency and public participation; – Adequacy of legislative branch review; and – Perceptions of foreign control of domestic assets and the role of local contractors. • Terms of PPP agreements: – Asset control and ownership; – Tolling policy; – Non-compete and other unanticipated event pro- visions; – Use of proceeds and revenue sharing; – Maintenance standards and hand-back provisions; – Environmental safeguards; – Labor relation issues; – Length of agreement; – Termination and buyouts; – Safety and enforcement; – Commercial development rights; – Data privacy and ownership; – International trade agreement implications; and – Liability, indemnification, and insurance. PROJECT SELECTION AND DELIVERY Criteria for Deciding Whether to Use a Public–Private Partnership Approach Various factors have led to an increased interest in trans- portation PPPs by public decision makers in recent years. The existing transportation infrastructure is aging and travel demand continues to increase. At the same time, tra- ditional transportation revenues are growing at a slower rate than transportation needs, leading to an increasing funding gap. CHAPTER THREE PUBLIC–PRIVATE PARTNERSHIPS DECISION-MAKING TOPICS Opinion/Comment from “Other Individuals/Interest Groups” Survey: CONCERN: Inadequate criteria for selecting candidate projects for P3 implementation. MITIGATION: Better public sector understanding of the trade-offs inherent in P3—private sector money is not “free” and P3 is not necessarily the answer when everything else has failed. In response, some governors, legislators, and others in posi- tions of transportation policy leadership have proposed raising motor fuel taxes or vehicle fees to close the transportation funding gap; however, few attempts at revenue enhancement have succeeded. It is tempting for government to consider PPPs a “quick cash” scheme to close the transportation fund- ing gap, but in reality, a PPP provides several tools that can help narrow the gap between transportation needs and fund- ing. Many aspects of PPPs introduce extensive changes to the way things have always been done, and the changes may not be well understood. With this in mind, PPPs must be pursued carefully, and decision makers need a set of cri- teria to help guide the decision between using a PPP or tra- ditional procurement when considering their transportation priorities. Opinion/Comment from “Other Individuals/Interest Groups” Survey: Put in place solid PPP processes that help promote the best projects and finance plans moving forward and limit the highly risky projects/schemes from moving forward. OECD, in its Principles for Private Sector Participation in Infrastructure (2007), laid out the following four principles

related to the decision to provide infrastructure services by the public or private sectors: 1. The decision should be based on a cost-benefit analysis that includes all alternative procurement and delivery methods, and both financial and non-financial costs and benefits should be projected over the project life cycle. 2. The project sponsor should assess how the costs of infrastructure will be recovered (e.g., user-fees), and what other financing sources are available in case of shortfalls. 3. The selection of a PPP model and allocation of risks should be based on the public interest. 4. Fiscal discipline and transparency must be safe- guarded, and the potential public finance implications of PPPs must be understood. Countries with extensive experience in PPPs have devel- oped guidance (see Table 2) that might be useful to states considering PPPs for project delivery. Project sponsors must note that each PPP project is different and these guidelines might have to be adapted on a case-by-case basis. Not all projects present viable opportunities for a PPP. Public decision makers need to understand the criteria for suc- cessful projects to inform their decisions about whether or how to involve the private sector in what has traditionally 12 been a public sector enterprise. The enabling legislation in nine states includes specific criteria to evaluate PPP propos- als. Only 9% of the respondents to the DOT survey indicated that a lack of PPP criteria is not important. In addition, the lack of criteria to evaluate candidate projects for PPP imple- mentation was called an important concern by one respondent of our survey of other interested parties. These respondents suggested that the public sector needs a better understanding of the trade-offs inherent in PPPs, and in particular that PPPs are not “the answer when everything else has failed.” Several studies that address selection of PPP projects have been published (Zhang 2005; Abdel-Aziz 2007; AECOM 2007b). Abdel-Aziz (2007) suggests that the decision to pro- ceed with a PPP should depend foremost on the program- matic environment. If the program environment is supportive of PPPs, only then should project-specific characteristics be evaluated. Abdel-Aziz identifies eight critical success factors at the programmatic level: 1. Availability of a PPP institutional/legal framework, 2. Availability of PPP policy and implementation units, 3. Perception of private finance objectives, 4. Perception of risk allocation and contractor’s com- pensation, 5. Perception of value-for-money, 6. PPP process transparency and disclosure, TABLE 2 LIST OF FOREIGN GUIDANCE DOCUMENTS FOR PPP PROJECTS Country Guidance Document URL United Kingdom Standardisation of Private Finance Initiative Contracts, Version 4 (Mar. 2007) http://www.hm-treasury.gov.uk/documents/ public_private_partnerships/ppp_standardised_contracts.cfm Canada (province of Alberta) Alberta Infrastructure and Transportation, Management Framework: Procurement Process (Sep. 2006) http://www.infratrans.gov.ab.ca/ INFTRA_Content/doctype309/production/ait-p3- procurementframework.pdf Canada (province of Alberta) Alberta Infrastructure and Transportation, Management Framework: Assessment Process (Sep. 2006) http://www.infratrans.gov.ab.ca/ INFTRA_Content/doctype309/production/ait-p3- assessmentframework.pdf Australia (Victoria) Partnerships Victoria, Policy and Guidelines (various documents) http://www.partnerships.vic.gov.au/CA25708500035EB6/0/ C0005AB6099597C2CA2570F50006F3AA?OpenDocument Netherlands Ministry of Finance, DBFM Manual, Version 5 (Jan. 2008, in Dutch) http://www.minfin.nl/nl/onderwerpen,publiek-private- samenwerking/publicaties/DBFM-algemeen.html Ireland Department of Finance, Central PPP Policy Unit (various documents) http://www.ppp.gov.ie/keydocs/guidance/central/ Note: URLs last accessed on May 28, 2008.

13 7. Standardization of PPP procedures and contracts, and 8. Performance specifications and method specifications. Once a transportation agency has established a PPP program, it can more effectively develop individual projects (AECOM 2007b). Zhang (2005) suggests 47 project-specific critical success factors in five categories: 1. Favorable investment environment, 2. Economic viability, 3. Reliable concessionaire consortium with strong tech- nical strength, 4. Sound financial package, and 5. Appropriate risk allocation via reliable contractual arrangements. The author surveyed both academics and practitioners with respect to the importance of these subfactors, and compared the differences between the survey results of academics with all those surveyed. He concluded that academics and practi- tioners at-large generally agree on the relative importance of the critical success factors. The AECOM “Guidebook” (2007b) reviews key criteria from both public and private perspectives for identifying potential projects to pursue as PPPs; the criteria that are gen- eral precedents to successful implementation of PPPs by the public partner are summarized here. • Enabling legislation in place, • Urgent transportation need, • Political and institutional support, • Lack of internal resources to effectively deliver the project, • Leverage public resources and transfer risks to private sector, • Expedite schedule through access to capital markets and innovative project delivery, • Increase cost-effectiveness through best practices and access to new technology, • Competitive market environment based on firms with proven experience, • Capability to manage transparent procurement/contract administration processes, and • Public accountability through monitoring of contract performance standards. PPP Enabling Legislation Enabling legislation is a necessary step for any PPP imple- mentation and it can be provided on a project-by-project or program basis. PPP legislation in seven states limits PPPs to selected “pilot” or “demonstration” projects. Project-by-project-enabling legislation allows public rep- resentatives to consider the details of each project. However, the competitive nature of PPP procurements in one instance apparently led to withholding proprietary technical informa- tion from elected officials, even as they voted to approve a project. In the case of The Canada Line, an extension of the Vancouver urban rail line, local elected officials responsible for approving the PPP responded to public criticism by claim- ing that they did not know the extent of the controversial cut- and-cover tunneling method to be used on the project. Because the amount of cut-and-cover tunneling was a proprietary part of the contractor’s bid information regarding its use that was appropriately withheld—this did prevent the elected officials from not getting a complete picture of the project that they approved (Siemiatycki 2007). If more than one project is anticipated, however, project- by-project legislation is time and cost intensive for both the public and private sector, and standardization of PPP proce- dures can streamline the procurement process. The United Kingdom developed a standardized Private Finance Initiative contract to simplify negotiations, enable consistent pricing of projects, and promote common understanding of risks among PPP projects (Abdel-Aziz 2007). Ghavamifar and Touran (2008) conducted a comprehen- sive survey of the codes of all 50 states within the United States to identify enabling legislation for alternative project delivery systems: design-build, construction management-at- risk, and PPP project. They found that an increasing number of states are moving toward more fully authorizing alternative delivery systems. According to a study prepared for the FHWA, state- enabling legislation should, at a minimum, provide an oper- ating environment that allows a state DOT to enter into part- nerships and to approve specific activities associated with that partnership. To be effective, it could designate a lead agency, such as the state DOT or a toll authority to imple- ment highway partnerships. The lead agency should have the authority to act on behalf of the state and should have certain statutory powers including the power to procure projects through negotiation, to acquire right-of-way through eminent domain (or otherwise) and transfer use of it to a private part- ner, to acquire and confer environmental permits, to confer exclusive franchises, to establish a geographic non-compete zone, to enter into binding concession agreements and lease arrangements, to regulate tolls or rates of return, to accept unsolicited proposals, and to blend or lend state and federal funds to a project (Apogee Research, Inc. 1995; U.S.DOT 2004). Enabling legislation may also include provisions that define the maximum repayment term for debt (e.g., 30 years) and surety/performance bond requirements. Bloomfield (2006) warns against relaxing procurement laws too much, citing an example of local enabling laws that waived the need for com- petitive procurement for a long-term lease of a new cor- rectional facility in Plymouth, Massachusetts. On the other hand, some terms provided by enabling legislation may dis- courage the private sector from investing in transportation

infrastructure. For instance, the PPP legislation in Washing- ton State requires post-legislative approval of proposed PPPs after a private partner has been selected, which some observers say appears to have discouraged private investors from sub- mitting unsolicited proposals, because there is no guarantee that the negotiations will be closed even after a PPP project has been selected and approved by the DOT. Public Interest Evaluation Some government sponsors have found value in setting out specific criteria that need to be met before a PPP can be pursued. A recent GAO report, Highway Public-Private Partnerships . . . (2000a) on PPPs reported that the states of Victoria and New South Wales in Australia have developed the following criteria that consider the public interests before entering into a PPP agreement. In New South Wales, the pub- lic interest evaluation is conducted before advertising the project as a PPP, and the analysis is constantly updated as the project moves through the procurement process, including before the government signs the PPP agreement. • Victoria 1. Effectiveness in meeting government objectives 2. Accountability and transparency, ensuring that com- munities are informed of both public and private sector obligations, and that there is oversight of projects 3. Affected individuals and communities, whether they have been able to contribute during planning stages, and whether their rights are protected through appeals and conflict resolution mechanisms 4. Equity, ensuring that disadvantage groups can make use of infrastructure 5. Public access, whether there are safeguards to ensure access to essential infrastructure 6. Consumer rights, whether the project provides safe- guards for consumers 7. Safety and security of the community are secured 8. Privacy, whether the project adequately protects users’ rights to privacy. • New South Wales 1. Effectiveness in meeting government objectives 2. Accountability and transparency, ensuring that com- munities are informed of both public and private sec- tor obligations, and that there is oversight of projects 3. Value for Money used to determine if the PPP approach is in the public interest 4. Community consultation, whether affected individ- uals and communities have been able to contribute during planning stages 5. Consumer rights, whether the project provides safe- guards for consumers 6. Health and safety of the community are secured 7. Privacy, whether the project adequately protects users’ rights to privacy. 14 Unsolicited Proposals and the Transportation Planning Process The use of a PPP raises concerns that private investors may circumvent the transportation planning process set by state, regional, and local governments, specifically by allowing them to submit unsolicited proposals. The public concern is that the private sector will “cherry-pick” the most profitable projects, leaving the public sector with other needed, but less profitable projects (Buxbaum and Ortiz 2007). Others may argue that the most profitable projects might be those with the highest projected traffic and therefore the most needed. Attracting private investment for these projects would leave public funds available for other needed projects that may not be good candidates for PPPs. An unsolicited proposal is a bid by a private company to the government for a project for which proposals have not been solicited. Unsolicited proposals are sometimes perceived to serve special interests or favor individual companies. Mean- while, a variety of stakeholders including state representatives, law firms, private companies, and trade associations recom- mend elimination of state prohibitions on accepting unso- licited proposals (U.S.DOT 2004). Conversely, in a letter to state DOTs, Congressmen Oberstar (chairman of the House Committee of Transportation and Infrastructure) and Con- gressman DeFazio (chairman of the House Subcommittee on Highways and Transit) (2007), asserted that states should not allow unsolicited proposals because they circumvent the estab- lished planning process by favoring projects that are profitable to private developers. A response from the National Governors Association (NGA 2007), asserted that PPPs have been care- fully evaluated by states to ensure that the public interest is protected, and that a PPP proposal where the public interest is not protected should not be considered. Opinion/Comment from “Other Individuals/Interest Groups” Survey: Because a private corporation is most interested in the most profitable project, and not the one that is most needed, they may force the public agency to entertain construction of pro- jects that are not a priority for the public—but of course the public will pay. Opinion/Comment from “Other Individuals/Interest Groups” Survey: CONCERN: PPP may undermine comprehensive trans- portation planning and work of MPOs [Metropolitan Plan- ning Organizations]. MITIGATION: Require PPP projects to be consistent with state, local, and MPO transportation plans. PPP projects need to be part of plans, not separate from them.

15 The interested party’s survey done for this synthesis con- firmed this concern and provided some mitigation suggestions: • Require PPP projects to be consistent with state, local, and MPO transportation plans; • Prohibit PPP vendors from participating in project plan- ning activities; • Limit or prohibit unsolicited bids; and • Provide sufficient time for submittal of competing proposals. International experience suggests three methods that deal with unsolicited proposals in a way that introduces competi- tion and transparency (Hodges and Dellacha 2007): 1. The “Bonus System” invites additional competition but gives a small advantage to the unsolicited bidder. Thus, later bidders are incentivized to submit high-quality, low-cost projects, but may have slightly less incentive to submit at all. This system is used by Chile and South Korea. 2. The “Swiss Challenge System” invites additional com- petition and gives the unsolicited bidder the opportu- nity to beat or match the new bids. This system is used by Guam, India, Italy, and Taiwan. 3. The “Best and Final Offer System” involves multiple rounds of tendering and the original bidder is automat- ically guaranteed participation in the final round. This system is used by South Africa and Argentina. British Columbia developed its Capital Asset Manage- ment Framework to standardize and streamline its PPP pro- curement process. The Capital Asset Management Framework follows a three-stage process of solicitation, evaluation/ negotiation, and contract award and allows for unsolicited proposals, but invites competitors to submit a better pro- posal. It adopts the Swiss Challenge System (Abdel-Aziz 2007). PPP legislation in 18 states allows unsolicited proposals for PPP projects. One of the first laws to enable use of trans- portation PPP, Virginia’s PPTA of 1995, allows private entities to submit both solicited and unsolicited project pro- posals and specifies similar steps to evaluate, select, and implement both types of projects (U.S.DOT 2004). Changes to the PPTA law in 2005 direct the program toward solicited proposals, although the Virginia DOT may still accept unso- licited proposal by statute. In the case of unsolicited propos- als, Virginia has developed a quality control process in which unsolicited proposals are reviewed to determine if these are in the interest of the public sector and then make a decision on whether the project should be pursued. The Commonwealth’s PPP guidelines provide that if the state decides to moves for- ward with the proposed project, competing proposals may be submitted within a minimum of 90 days if the project does not involve federal funding, or a minimum of 120 if using federal funding. Buxbaum and Ortiz (2007) noted that short time periods for competing proposals may lead to inadequate competition among bidders. On the other hand, a long period may dis- courage private investors in submitting unsolicited proposals. Roles of Public and Private Sectors, Risk Allocation, and Rates of Return The roles and responsibilities of public and private sectors under traditional procurement are well understood by state DOTs, architectural/engineering firms, and contractors that are involved in the process. The introduction of a PPP changes the traditional roles of these entities in the development, operations, and management of transportation infrastructure. The public sector’s goal is to provide a transportation infra- structure (and system) that is safe and improves user mobil- ity, whereas the private sector’s main goal is to achieve a return on investment. Because these goals may be in conflict, the public sector must ensure that the assignment of roles, responsibilities, and risk is done in a manner that protects the public goals. Risk Transfer The transfer and sharing of project risks is considered by many as one of the main benefits of PPPs. Much of the risk associated with the design, construction, financing, operations, and maintenance of transportation projects is traditionally managed by the government. In contrast, a PPP seeks to allo- cate risks to the parties best able to manage them (Bettignies and Ross 2004; U.S.DOT 2004). Three factors drive risk sharing in PPPs. First, the private sector is in charge of a number of activities during the lifetime of the project, includ- ing financing, whereas the government usually holds a resid- ual ownership right. Second, the two contracting parties in a PPP arrangement have different stakeholders and different objectives, risk perceptions, and constraints. Third, the pub- lic and private partners may have different abilities to diver- sify the risk (Checherita and Gifford 2008). For example, the private partner can diversify the risks of construction and financing across many projects. Concern about how this risk allocation is handled was borne out by the two surveys done for this synthesis. Risk sharing and allocation among public and private sectors on PPPs is considered as an either “very important” or “somewhat important” concern by all respondents in our state DOT survey, with 88% responding that it is a “very important” concern. Also, most U.S. states and Canadian provinces that have completed or are currently are negoti- ating a PPP project use risk assessments when considering PPP proposals. One of the respondents to our interested parties’ survey identified the need for strong demarcation of responsibili- ties between the public and private sectors. In the survey, the

Central Artery/Tunnel project in Boston (also known as the “Big Dig”) was cited as an example of a project where there was a “too cozy” relationship between the public and private sectors leading to lack of oversight and enforcement of pub- lic interests. The Big Dig included a design and construction management contract with a joint venture between two large engineering firms, where considerable independent responsi- bility was handed over to the private sector. Another survey respondent indicated that the public sector may be unaware of what risks are being transferred and which ones remain. 16 efforts to limit foreign involvement or state/local polit- ical and public grassroots efforts to oppose PPP with significant foreign company involvement. • Political stability—Continuity of political support for a PPP project should there be a change in political struc- ture or composition. • Moral hazard—Public sponsor to avoid conflict of inter- ests and fraudulent activities during procurement and execution phases of the project. Public sector to hold PPP provider publicly accountable for proper execution of the project consistent with the terms of the contract agreement. • Demand/volume—Level and timing of traffic. • Revenue—Level and timing of proceeds from tolls or congestion pricing of highway use. • Environmental/archeological—Site conditions that may require mitigation, and the cost of mitigation measures and their responsibility. • Right-of-way costs—Uncertainty in cost of acquiring parcels of land needed for project. • Construction costs—Impacts from availability and cost of materials, labor, and maintenance of traffic, plus the cost of surety bonds. • Maintenance costs—Cost of maintenance and repair activities that may be affected by factors such as quality of design and construction, and changes in traffic vol- umes, among others. • Liability/latent defect—Potential for defects in design or construction, and the effect on project costs and the responsibility for paying these costs. • Life-cycle costs—Cumulative costs of facility mainte- nance, rehabilitation, and reconstruction/expansion over the term of the contract and its effect on cash flow and reserves. • Regulatory/contractual—Changes in regulation or con- tract provisions that affect the cost exposure of one or more partners. • Payment structure/mechanism—Effect on value of proj- ect participation based on source, method, and timing of project cost reimbursement or availability payment. • Transaction costs—Level of costs associated with com- pleting various transactions involved in completing the PPP contract agreement and responsibility for payment of these costs. • Changes of law—New statutes and regulations, includ- ing design/construction standards, which affect the cost of the project and delivery schedule. • Compensation/termination—How PPP team will be compensated for work completed if contract is termi- nated, depending on reasons for termination, and any penalties for early termination by the sponsoring agency. • Economic shifts—Changes in economic activity and demography of the region that could affect traffic and revenue over the term of the contract. • Currency/foreign exchange—Changes in relative value of national currencies that can affect the cost of the Opinion/Comment from “Other Individuals/Interest Groups” Survey: How can distribution of transportation benefits/burdens and risks be decided in a strategically equitable manner? Government deal making in transportation infrastructure development may only include stakeholders and interests of upper class membership. However, it is the role of gov- ernment to assure that these deals benefit society as a whole, including the underclasses. If the spectrum of pub- lic interests is not represented, inequitable distributions of benefits, burdens, and risks may occur. There must be an approach to uncovering hidden and indeterminate public risk. In a PPP, the paradigm for business interests where the business interest short term gain means the long-term public loss, must be changed. The public interest must be of paramount benefit. The FHWA’s PPP website (2008) and Table 2 in chapter two show a continuum of public/private mixes in order from those of greatest public responsibility to those of greatest pri- vate responsibility. The amount of risk allocated to each party depends on the type of partnership, the risk profile of each partner, and details specified in the partnership contract. Allo- cation of risks among private and public partners has been reviewed extensively in the literature (Fishbein and Babbar 1996; FHWA 2004; AECOM 2007b; Checherita and Gifford 2008). Checherita and Gifford (2008) provide a comprehen- sive typology of risks and identify risks most likely to arise under a PPP arrangement rather than under traditional financ- ing or complete privatization. Risks are classified in three broad categories: (1) fiscal risks, (2) residual value or valua- tion risks; and (3) bidding risks. AECOM (2007b) provides discussion of risks, as summarized here: • Public acceptance—Degree of public acceptance of the project, its procurement as a PPP, and the means by which the project will be paid (e.g., tolling). • Control of assets—Perceived loss of control, particularly the level and frequency of toll rate increases, physical condition and appearance of the facility, and protection of the public interest. • Protectionism—Concern about nationality of firms com- prising the PPP team, which may result in legislative

17 project and value of revenue to a PPP provider based on another country with different currency used for project reimbursement or payment of revenue proceeds. • Taxation constraints—National, state, or local taxes on the materials used in developing the transportation facil- ity and the proceeds from operation of a priced facility that can affect financial viability. AECOM (2007b) also provides a detailed table summa- rizing risks fully or partially transferred to the private sector based on 17 types of alternative PPP approaches, as shown in Table 3. For instance, in a DBFO agreement, finance, design, construction, construction inspection, maintenance, opera- tions, and traffic-revenue risk are often transferred to the pri- vate sector. In a PPP, risk should be allocated to the party that can best manage such risk. According to a 2008 GAO study, some of the typical risks transferred to the private sector include proj- ect construction/schedule risks and traffic/revenue risks. The GAO report noted international examples that show the ben- efits of transferring the aforementioned risks to the private sector. One such project was the CityLink highway project in Melbourne, Australia, which was subject to extensive delays and additional costs. Because all construction risks had been transferred to the private sector, none of the additional costs of this project were a responsibility of the public sector. An example of the benefits of transferring traffic and revenue risks cited in the GAO report is the Cross City Tunnel in Syd- ney, Australia, where public officials have indicated that the public sector has not been affected (financially) by the low traffic and revenues, because those risks were borne by the private sector. The project was sold in 2007 to new private owners, after the first concession failed. The original Pocahontas Parkway project, on the other hand, is an example of what some might consider poor risk allocation on the part of the public sector. Under the original Functional Responsibilities and Project Risksa Alternative PPP and Procurement Approaches Pl an ni ng En vi ro nm en ta l Cl ea ra nc e La nd A cq u isi tio n Fi na nc e Pr el im in ar y D es ig n Fi na l D es ig n Co ns tru ct io n Co ns tru ct io n In sp ec tio n M ai nt en an ce O pe ra tio ns Lo ng Te rm Pr es er v at io nb Tr af fic - R ev en u e A ss et O w ne rs hi p Asset Sale Greenfield Concession Brownfield Concession Multimodal Agreement Joint Developmentc Transit-Oriented Developmentc Build-Own-Operate Build-Own-Operate- Transfer Build-Transfer- Operate Design-Build- Finance-Operate Design-Build- Operate-Maintain Design-Build w/ Warranty Design-Build Construction Management at Risk Contract Maintenance Traditional Design- Bid-Build aFunctional Responsibilities and Project Risks noted with a check mark ( ) may be transferred in whole to the private partner or shared with the public sponsor, depending on the contract. bRefers to long-term risk of asset failure or physical obsolescence. cRefers to private developer portion of infrastructure. Source: FHWA Office of Policy and Governmental Affairs, ìUser G uidebook on Implementing Public Private Partnerships for Transportation Infrastructure in the United States,” prepared by AECOM, July 2007. TABLE 3 RISK TRANSFER RESPONSIBILITIES UNDER DIFFERENT PPP ARRANGEMENTS

PPP agreement, the Virginia DOT would operate and main- tain the facility, thus retaining some of the traffic and revenue risk by providing funding to cover operations and mainte- nance (O&M) until the facility generated sufficient toll rev- enue to meet its debt obligations, fully cover O&M expenses, and pay back the state’s investment [including both capital (State Infrastructure Bank loan) and O&M]. Actual traffic was much lower than projections, and revenues were not suf- ficient to pay back debt (with bond holders bearing this risk); therefore, the state paid for O&M expenses on the facility until it was leased in 2006. Some of the risks that are better managed by the public sec- tor include environmental, right-of-way acquisition, statutory/ regulatory, and public acceptance risks (AECOM 2007b). The environmental process can be lengthy, especially if federal funding is involved, and can add significantly to the project cost (GAO 2000b). The South Bay Expressway in California is a good example of the environmental risk and uncertainty: it took almost a decade after the project had been awarded to a private partner to get environmental clearance (AECOM 2007b; GAO 2000b). The delay resulted in increased construc- tion costs and foregone toll revenues. The original private part- ners sold the franchise to Macquarie Infrastructure Group in 2003, and shortly after construction of the facility began (AECOM 2007b). Risks are not always fully transferred from one entity to another. For example, some PPP arrangements include traffic/ revenue risk sharing and/or include mechanisms that help mitigate the traffic risk to the private sector (Izquierdo and Vassallo 2004). Minimum revenue guarantees (Chile) or eco- nomic rebalancing provisions (Spain) are used to mitigate this risk. In the case of minimum revenue guarantees, the conces- sion contract also includes revenue sharing if traffic exceeds projections, such that the public sector also benefits from addi- tional revenues. Rebalancing provisions allow for revision of toll rates or changes in the length of the concession if a chosen metric (e.g., traffic, revenues) falls outside a specified range. Rate of Return The main objective of the private sector in a PPP is to achieve a target return on investment on the equity invested. The European private sector expects a return on its investment of 7% to 17% (Jeffers et al. 2006). Data analysis by Infrastruc- ture Management Group shows that the long-term return on equity on recent concession deals involving “brownfield” toll roads was expected to be around 12%, whereas returns of 14% or higher were expected on greenfield projects (Page 2008). Buxbaum and Ortiz (2007) identified windfall rev- enues as one of the main public concerns related to long-term concessions. This concern was further validated by the pub- lic agencies surveyed in this synthesis, where all but one respondent indicated that excessive rates of return to private investors are an important concern. 18 Revenue sharing provisions, refinancing regulations, and contract rebalancing provisions are strategies that allow the public sector to benefit from revenues that are higher than projected and/or limit excessive returns to the private sector (Mayer 2007). In Virginia, both the Pocahontas Parkway and the I-495 Capital Beltway HOT lanes concessions include provisions requiring the private partners to share toll rev- enues based on the rate of return achieved. Revenue sharing provisions are also common in Texas’ CDA and were also included in the Northwest Parkway lease agreement. Some observers have suggested that a facility should be returned to the public sector once the private partner has met a specified rate of return, and the French and Spanish conces- sion models allow for termination of a concession once an agreed upon internal rate of return is achieved, although esti- mating and determining when the rate of return has been achieved could be difficult (Mayer 2007; see also section on Use of Proceeds and Revenue Sharing later in the chapter). This would allow for the benefits of private capital being used for transportation infrastructure, but also guard against excess profits. However, it provides no incentive to keep costs down. Another way that the public sector can maximize the work performed in a PPP agreement that is based on a set amount of available funding is through “bidding scope,” which has been used by the Missouri DOT. On the I-64 reconstruction project, the Missouri DOT set a “not to exceed” price avail- able for the project and provided some minimum scope items, as well as a conceptual design of the project for information. The bidding teams were asked to propose the “most scope” they could deliver for the set price, and this was evaluated as the most significant portion of the “best value” determination. A similar approach is currently being considered for the re- bid of Missouri’s bridge program to replace more than 550 of the state’s lowest-rated bridges. The Missouri DOT will set a price and then list all the bridges to be replaced in a priority order. Bidding teams will be asked to propose how many bridges from this list they would complete for a set price. Public–Private Partnership Valuation Tools The decision to pursue a PPP project should be supported by analytical processes that show the PPP procurement as a bet- ter option than traditional procurement or public provision. The valuation process should include the careful selection of inputs/variables that properly characterize the chosen procure- ment method and risk allocation, using quantitative methods that include sensitivity analysis to better assess the risk vari- ables for a particular project. Several states in the United States, including Florida and Alaska, as well as the United Kingdom, Victoria (Australia), and British Columbia have widely used “value for money” as a tool to assess PPPs. Other methods have also been used in the United States, including shadow bids and market valuation in Texas, and asset valuation in both Chicago and Indiana, to set a minimum value for the pro- posed project. Proper development and use of valuation tools

19 is potentially one of the most important means of helping the public and elected officials better understand the benefits, costs, risks, and rewards of PPPs. oversight of PPPs in Europe (Jeffers et al. 2006). The report indicates a need for personnel with skills, including value engineering, business modeling, capital budgeting, traditional financial problem-solving methodology, and performance auditing. The report concludes that a state DOT team should develop a public sector comparator (PSC) and a business model for each PPP opportunity to determine whether the project can return VfM to public. Grimsey and Lewis (2005) and Morallos and Amekudzi (2008a) have thoroughly explored the VfM concept. Although cost-benefit analysis is widespread, there are few examples of VfM in the United States, largely because of the limited experience with PPPs. British Columbia, the United Kingdom, and Victoria, Australia, have made PPP/public procurement decisions for many projects using VfM analysis and have established set procedures for its calculation. Table 4 provides a list of some of the publicly available guides for VfM analysis. An estimate of VfM is achieved by calculating the present value of the PSC and then comparing it with one or more bids from private companies. The PSC examines life-cycle proj- ect costs, including construction, operations, maintenance, and additional improvements that will be incurred over the course of the concession term (GAO 2000b). To prepare the PSC, the sponsoring agency needs to define the project scope in advance to the extent that a realistic determination of what project requirements, costs, and revenues are likely to be. This may involve the following actions: • Develop greater understanding of project geotechnical and site conditions through advanced reconnaissance; • Advance project design to the point where there is a clear understanding of the key attributes of the project design and functional characteristics; • Perform advanced value engineering to ensure that the most cost-effective design parameters are considered; • Revise assumptions typically used to estimate traffic volume and revenue potential, especially the possible size and frequency of toll rate changes when tolling is involved to reflect current fiscal concerns; • Recognize the risks inherent in the inflationary effects on the costs of project materials (AECOM 2007b); and • Consider value of speed in construction execution asso- ciated with minimizing public inconvenience. Once the characteristics of the project are better under- stood, the PSC is constructed using four components: 1. Raw PSC is the discounted cash flows of benefits and costs attributable to the project assuming no pri- vate sector involvement. Cash flows are discounted by a rate reflective of the government’s time value of money plus a systematic risk premium for risks inherent to the project. Costs include direct and indi- rect costs and are reduced by third-party revenues including user charges, increased demand for a facility Opinion/Comment from “Other Individuals/Interest Groups” Survey: Need to adopt level-playing-field competition procedures, to permit fair competitions that do not tilt toward either public- sector or private-sector bidders. Value for Money Analysis and Other Valuation Tools Consideration of the PPP option can be fraught with emo- tionally charged ideological rhetoric, but this debate can be informed by well-defined and executed business case analy- sis. Value for Money (VfM) calculates the difference between the costs and benefits associated with both traditional and PPP procurements. Some of the benefits to developing a finan- cial model to evaluate PPP proposals include (Oakley 2008): • Helps establish the business case for a PPP, • Provides important insights about the project’s ability to obtain financing, • Allows for testing of assumptions (e.g., toll increases, traffic growth, length of agreement) early in the process, and • Provides a method for “optimizing” the transaction and encouraging competition and innovation. The VfM analysis has been widely used outside the United States, particularly the United Kingdom. Our state DOT survey confirms that the availability and consistent application of evaluation tools, such as VfM, are important to state decision making. Of the nine states that have at least one PPP project in place, two (22%) have not used VfM, and four (44%) reported using VfM frequently. The preliminary results of a survey of VfM analysis tools in the United States conducted by Morallos and Amekudzi (2008b) showed that only one-third of the states use VfM or similar tools to eval- uate PPPs. Florida, Virginia, and Oregon reported using VfM. Texas has used a process called “shadow bids” for two PPPs. These involve the state, through its own resources and consultants, making detailed estimates of design and construc- tion costs, operating costs, and a detailed financial model (GAO 2000b). The results of the shadow bids are compared with the private sector proposals. In addition, the moratorium bill passed in 2007 (SB 792), requires the Texas DOT to conduct a “mar- ket valuation” analysis for new toll roads to assess how much value a facility might attract from the private sector. An International Technology Scanning report by the FHWA documented best practices regarding audit stewardship and

or service, or payments received by third-party use of the facility. 2. Competitive neutrality value removes inherent com- petitive advantages or disadvantages of a government agency compared with the private sector. This value is added to the PSC to allow for comparison with the PPP option. For example, public sector advantages include exemptions from land taxes or other taxes and fees that would otherwise be levied from a private investor. On the other hand, public sector disadvantages may include political risks or economies of scale that would allow the private sector to operate more efficiently. 3. Transferable risks are those that are likely to be trans- ferred from the procuring agency to the chosen private partner(s). The risk valuation includes estimating the probability of the risk occurring, and could be a simple estimation of an amount above or below the raw PSC, or the application of Monte Carlo simulation using a probability distribution of risk. 4. Retained risks are those risks that the public partner will retain. The present value of retained risks will also be added to the cost of the private bids to reflect the true cost of the PPP options. The four components are summed and compared with the combined cost of the private bids and the cost of the public’s retained risks, as shown in Figure 1. 20 Besides the previous quantitative analysis, qualitative factors could also be considered. The public agency must identify the objectives and desired project outcomes and translate these into the performance standards on which to base the payment mechanism. The qualitative analysis con- siders whether the long-term contract can meet the objec- tives. It also considers important regulatory, public equity, efficiency, or accountability issues. Does the PPP improve on traditional delivery, financing, management, operations, or maintenance structures? Is the PPP procurement option feasible given current market conditions, the public agency’s available resources (monetary and management experience), and the attractiveness of the proposed project? The GAO (2000b) found that both the states of Victoria and New South Wales, in Australia, have used qualitative analysis, along with quantitative analysis, to evaluate how the public interest is affected in a PPP. Although VfM appears to be a useful tool to lead the PPP decision process, there are several criticisms of the VfM process. The most significant is that the PSC is a hypotheti- cal case entirely dependent on the experience of the person(s) conducting the calculation. Inaccurate or erroneous estimates of cost and/or risk may seriously impair the PSC (Bloomfield 2006). Furthermore, the PSC is estimated using numerous assumptions and projections well into the future, adding a high degree of uncertainty (GAO 2000b). TABLE 4 VALUE FOR MONEY GUIDES Country Docum ent URL United Kingdom HM Treasury, Value for Money Assessm ent Guidance (Nov. 2006); Value for Money Quantitative Assessm ent User Guide (Mar. 2007) http://www.hm -treasury.gov.uk/docum ents/ public_private_partnerships/additional_guidance/ ppp_vfm _index.cfm Canada Industry Canada, The Public Sector Com parator: A Canadian Best Practices Guide (2002) http://strategis.ic.gc.ca/pics/ce/ic_psc.pdf Victoria, Australia Partnerships Victoria, Public Sector Comparator (2001); Public Sector Com parator Supplem entary Technical Note (2003) http://www.partnerships.vic.gov.au/CA25708500035EB6/0/ C0005AB6099597C2CA2570F50006F3AA? OpenDocum ent Ireland Central PPP Unit, Value for Money and the Public Private Partnership Procurem ent Process (2007); Co mp ilation of a Public Sector Benchmark (2007) http://www.ppp.gov.ie/keydocs/guidance/central/ Value%20for%20Money%20Technical%20Note.doc http://www.ppp.gov.ie/keydocs/guidance/central/ PSB%20Guidelines%20Jan%2007.doc Note: URLs last accessed on May 28, 2008.

21 Selection and Use of Assumption in PPP Valuation The concern about selection and use of assumptions is true for other valuation tools as well, such as those used to deter- mine the value of an existing asset for potential brownfield concessions. The NW Financial Group conducted a review of both long-term lease agreements for the Chicago Skyway and the Indiana Toll Road, concluding that the public sector could have generated as much revenue as the private sector (Buxbaum and Ortiz 2007; Enright 2007). The analyses for both projects included key assumptions, such as periodic toll increases, that are uncommon and politically difficult under public ownership. Similarly, a Pennsylvania Turnpike valu- ation (Foote et al. 2008) showed that public monetization would provide the best value ($26.4 billion for Act 44 com- pared with $14.8 billion for a 50-year asset lease), assuming that tolls are applied on I-80, which is an assumption that carries a very high risk. Later, a private offer for the Penn- sylvania Turnpike actually yielded $12.8 billion for a 75-year lease, which is about $2.0 billion less than Foote et al. estimates, for a longer lease term, which might be the result of current market conditions. Discount Rate for PPP Valuation There are highly contentious arguments among critics over using a higher or lower discount rate for the PPP. A recent analysis of the procurement options for the Pennsylvania Turnpike monetization (Foote et al. 2008) used different dis- count rates, further supporting this argument by applying lower discount rates to the public monetization scenario. The lower discount rate for the public monetization scenario was equivalent to the Pennsylvania Turnpike Commission’s (PTC) borrowing cost of 4.5%, whereas the discount rate of a pri- vate lease was estimated at 7.75%. The PTC discount rate was based on the yield of PTC’s AA/Aa3 debt in today’s market, and assumed that the state would pursue to public monetization as proposed in Act 44, which includes raising tolls on the Turnpike and adding tolls on I-80 (contingent to federal approval). The higher discount rate for the private monetization scenario was estimated based on the weighted average cost of capital, assuming 6.65% for private borrow- ing costs (for Baa rated corporate bonds), a cost of equity of 12.5%, and assuming an equity/debt ratio of 19% to 81% (based on the Indiana Toll Road concession equity/debt ratios). A critique to the Foote et al. analysis (Poole and Samuel 2008) suggested that the PTC discount rate should have been raised to account for risk, owing to the uncertainty of adding tolls on I-80. Grout (2003) recounts a decades-long controversy over this issue, and concludes that there are powerful argu- ments for using a higher discount rate for the PPP delivery mechanism. Valuation After PPP Contract Award Observers maintain that VfM analysis should be assessed even after the contract is awarded so that prices and risks may be readjusted as necessary to maintain VfM. However, it may be impossible to compare the actual costs of the project with the original PSC as the PSC quickly becomes obsolete; the origi- nal PSC is only valid before the PPP implementation (Edwards 2004; Stambrook 2005). Presumably this comparison cannot FIGURE 1 PSC and value for money comparison. Source: Grimsey and Lewis (2005).

be achieved because the original PSC would represent some ideal conditions that could have changed if the public sector implemented the project, and the actual PPP costs represent real conditions. Furthermore, the value of the PPP will con- tinue to change over time, and the actual value will be realized when the lease period expires, which, in the case of recent PPP projects in the United States, will occur many decades from today. Life-Cycle Costs As noted by Buxbaum and Ortiz (2007), future expansion and/or extensions, or other major capital improvements throughout the lease period, must be identified and the respon- sibilities for such investments should be defined in the con- cession agreement and included in the valuation process. The use of life-cycle cost analysis that includes the costs of initial construction, operations, maintenance, and other costs antici- pated during the life of a project has been encouraged by orga- nizations such as the ASCE. The use of life-cycle cost analysis may lead to higher project costs in the short term, but may lead to long-term savings in O&M (Lehman 2007). In addi- tion, for PPP projects that either include transfer O&M over a period of time or have warranty requirements, the private sec- tor is provided incentives to provide a higher quality of design and construction (Grout 2005) to minimize O&M costs. Additional Costs of PPP The use of PPP for transportation infrastructure brings some additional costs compared with traditional procurement (GAO 2008). The valuation and decision-making process to pursue a PPP should account for these to estimate the real costs of PPPs. These additional costs include: • Higher cost of borrowing (for private debt), although there are ways that the private sector can lower this, for example, with private activity bonds; • Foregone tax revenue, when tax-exempt debt is used, although this is revenue that may not have materialized in any case; • Cost of reviewing unsolicited proposals; • Cost of contracting financial and legal advisors, and/or developing PPP expertise in-house; and • Cost of performance monitoring. The first two items are related to the financing of the PPP project. The borrowing costs of private debt are higher than public tax-exempt debt; therefore, those higher costs are passed onto the public, either through a lower up-front payment (compared with the public sector issuing debt to raise money) or through higher toll rates than under public ownership—assuming tolls are part of the finance plan (Baxandall 2007). And, as discussed by Foote et al. on their Pennsylvania Turnpike monetization analysis, the cost of borrowing is expected to rise in the near term, with the current 22 credit crunch that is causing interest rates to increase, along with increases in the cost of bond insurance (although the latter affects both public and private debt). Foote’s evalua- tion concluded that because of the higher borrowing costs of the private monetization, toll rates under Act 44 (i.e., public monetization through the existing Turnpike Commission) were estimated at 71.5% the private toll rate. However, the use of public debt to support transportation infrastructure may be restricted by a state’s or toll authority’s debt capacity and statutory debt limits, and the unwillingness on the part of decision makers to regularly raise tolls to meet debt require- ments (Buxbaum and Ortiz 2007). In addition, some financial experts indicated that some tax benefits available to private investors (e.g., interest deductions and accelerated deprecia- tion) can help bridge the gap between tax-exempt and private debt (Florian et al. 2007). Furthermore, these federal tax pro- visions, combined with availability of other finance tools (e.g., Private Activity Bonds and TIFIA), may substantially reduce the cost difference between private and public debt (Goldman Sachs 2008). The financing package for some PPP projects included the use of tax-exempt debt, such as debt issued by 63-20 corpo- rations in the 1990s (e.g., Pocahontas Parkway) and, in more recent deals, the use of TIFIA and/or private activity bonds for toll road projects (e.g., I-495 Capital Beltway HOT lanes). GAO (2004) estimated federal foregone tax revenues of between $25 and $35 million in 2003 from outstanding debt for the Pocahontas Parkway, Southern Connector, and Las Vegas Monorail projects. The last three items on the list are related to the additional procurement and performance monitoring costs incurred by the public sector when deciding to have a PPP program. For example, unsolicited proposals require the state to devote time and resources for review (Buxbaum and Ortiz 2007). Although some PPP legislation allows states to charge a pro- posal fee, it may be insufficient to cover the actual costs of reviewing the proposal. Having a PPP program also requires the state DOT to either develop in-house expertise to evalu- ate and execute these deals or contract with legal and finan- cial experts, both resulting in additional costs to the agency, compared with the status quo (i.e., using only traditional pro- curement). Beyond procurement, the agency will also incur monitoring costs, especially if the contract specifies perfor- mance measures to be met by the concessionaire. Opinion/Comment from “Other Individuals/Interest Groups” Survey: [If deciding to pursue a PPP] “It must be clearly estab- lished that the same up-front borrowing could not be done more cheaply by public entities. The public should not pay a premium for higher private borrowing costs, oversight costs for monitoring private entities, and share- holder profits.”

23 formance warranties. Under the former, the contractor is responsible only for defects caused by poor materials and workmanship. Under the latter, the contractor is responsi- ble for the facility meeting certain agreed upon performance thresholds over an agreed upon period of time irrespective of whether materials and workmanship meet initial require- ments (U.S.DOT 2004). Warranties may have a higher initial cost because con- tractors may increase their initial bids to include contin- gency funds for correcting problems during the warranty period. However, warranties may result in lower life-cycle costs than those of traditionally contracted projects because there is an improvement in the quality of the initial project (U.S.DOT 2004). The Wisconsin DOT explored the rela- tionship between quality and whether or not the project had a warranty, and found that warranted pavements performed significantly better. The Wisconsin DOT study indicates the warranted pavements are performing better than similar non- warranted pavements based on the measured International Rough Index and Performance Distress Index (Carpenter et al. 2003). However, despite the performance advantages of war- ranties, some state transportation agencies cite the additional resources and expertise required to specifying them as a disadvantage. As mentioned earlier, the warranties require- ment may preclude smaller contractors from competing against larger firms that have the financial capacity to acquire large bonds that support the warranty requirement. Also, some contractors are reluctant to enter into warranty agree- ments owing to the increased liability and risk (Carpenter et al. 2003). Initial construction warranties (along with maintenance standard) were considered as an important concern by all respondents in our state DOT survey, with almost three- quarters of the U.S. respondents considering it as “very important.” Examples of warranties in practice are Virginia’s State Route 288 and New Mexico’s US Highway 550 (former SR-44). For Virginia’s State Route 288, a design-build- warranty approach, was chosen for the construction of 10.5 miles of new highway, expansion of 7 miles of exist- ing highway, construction of six new interchanges, modifi- cation of two interchanges, and construction of 23 bridges along the roadway to finish the road quickly and with min- imal delays. The project is thought to have been completed 3.5 years earlier than if a traditional DBB approach was used (U.S.DOT 2004). The state saved $47 million in construction costs, and the project was completed seven months ahead of schedule. New Mexico’s construction of US Highway 550 encom- passed an innovative warranty concept. In 1998, the state entered an agreement with a private partner to design, manage Bonding, Bonding Capacity, Letters of Credit, and Initial Construction Warranties Bonding Capacity of Contractors Many PPP projects are of such a size (more than $100 mil- lion) that small contractors may have difficulty obtaining financing. And, even if a smaller contractor had the financing capacity, the level of financial risk would negatively affect its bonding capacity. Performance bonding is an important ele- ment to a PPP, as it provides the public sector some assur- ance that a project will get completed if the concessionaire has financial difficulty. In its Report to Congress on Public-Private Partnerships (2004), U.S.DOT identified bonding capacity and warranty requirements as potential impediments to small businesses competing for PPP projects. This concern was echoed at a House Committee on Transportation and Infrastructure hearing on innovative contracting (April 2007) by various industry representatives. According to Thomas (2007), few sureties are willing to accept risk exceeding $250 million under any given bond. This situation is further affected by the requirement for extended warranties in many of these PPP projects. Warranties require larger bonds, driving project costs up, limiting participation as prime contractors of small and mid-sized companies. However, these companies can and do still participate as subcontractors. In contrast, an FHWA representative stated in his testimony that, in the case of design-build, the higher bond requirements, among other factors, do not appear to affect small businesses participation (Ray 2007). In his written testimony, Ray indi- cated that data on design-build contracting show that “the per- centage of design-build project costs going to small businesses is almost the same, on average, as the amount under the tra- ditional design-bid-build” contracting. A related concern is that states need to verify that their performance and payment bond statues allow flexibility that the private sector can respond to, because the amount and term of typical state statute bonds are not available in the marketplace. Warranties Warranties have been used for years in a wide variety of con- sumer products to protect consumers from inferior workman- ship. Historically, however, state DOTs have not used war- ranties for road construction but have internalized the risk of poor workmanship. Warranty clauses in PPP agreements guar- antee that a roadway will meet a certain level of quality or else repairs will be made at the private contractor’s expense. The intent is to create incentives for the contractor to deliver a high quality product to reduce future maintenance and repair costs. Two types of warranties are used in highway construc- tion: (1) materials and workmanship warranties and (2) per-

construction, and provide innovative warranties for the 118-mile highway segment. The warranties expire based on time (20 years for pavement, 10 for structures), money ($110 million for pavement, $4 million for structures), or equivalent single axle loads (ESALs) ($4 million for pave- ment, $2 million for structures), whichever comes first. An ESAL is defined by the FHWA as “the damage per pass to a pavement caused by a specific axle load relative to the damage per pass of a standard 18,000 pound axle load mov- ing on the same pavement.” The warranties cost $60 mil- lion for pavement and $2 million for structures, essentially leaving the private partner with a maximum monetary risk of $50 million for pavement and $2 million for structures (from the total monetary value of $114 million of the war- ranty). New Mexico DOT has been independently verify- ing ESAL calculations provided by the private contractor. Accurate calculation of current ESALs and projection of future ESALs is important because over-calculation could result in early termination of the warranties, and much of the expensive maintenance work is expected to take place towards the end of the contract. Findings of a recent report indicate that whereas expected ESALs in the early part of the contract were overestimated, the growth rate of ESALs was underestimated. However, recent data suggest growth in ESALs appears to slowing down (McClure et al. 2008). Yet, if the higher growth experienced over the first few years is sustained, the date of warranty expiration might be accelerated, requiring the New Mexico DOT to incur pave- ment maintenance expenditures toward the later years of the infrastructure life cycle. TRANSPARENCY PPP agreements are complicated, and there have been criti- cisms over deals being rushed through without the public or their elected officials understanding the implications. The following sections address issues related to public participa- tion in general, and involvement of the legislative branches of state government. Transparency and Public Participation The lack of transparency in the PPP process has been voiced as one of the main concerns throughout the literature review, including the newspapers and media reports, and it is men- tioned as an important issue by both supporters and opponents of PPPs. Buxbaum and Ortiz (2007) noted that transparency in the PPP process is key for public support of long-term con- cession agreements. The Chicago Skyway and the Indiana Toll Road concessions are particularly noted as examples in which transparency was lacking from the public perspective (as reported through the news media), even though public officials involved in these deals believed the process to be transparent and both transactions were subject to legislative review and approval of final terms. 24 Both the Regional Plan Association of New York, New Jersey, and Connecticut (Regional Plan Association 2007) and the U.S. Public Interest Research Group released position papers highlighting the importance of transparency as vari- ous states (including New Jersey, Pennsylvania, and Texas) unveiled their intentions to pursue long-term concessions on existing and new toll facilities. The RPA (2007) suggests full disclosure of: • Current and proposed contract standards, • Toll policy under PPP, • Revenue losses related to tolls used for other invest- ments, • Noncompete clauses or potential limitations to expan- sion of other transportation infrastructure, and • Transaction costs incurred by public sector. RPA further suggests that adequate opportunities for pub- lic input and legislative review are needed. Baxandall (2007) proposed that contract documentation should be available for public scrutiny at least six month before a deal is signed, and that legislators should have a vote on the final terms of a PPP deal. However, private parties may not be able or willing to hold their financial offers for such extended periods of time, and the political risk that this would entail could discourage private entities from submitting proposals. Opinion/Comment from “Other Individuals/Interest Groups” Survey: Balance needs for temporary confidentiality with full dis- closure of selection criteria, scoring, and concession agree- ment details. In our survey of state DOTs, only one state considered transparency as a “not important” concern, and this state has not considered or used PPPs to deliver highway projects. Approximately 30% of the interested parties survey respon- dents mentioned transparency as one of the main concerns related to and a factor to consider by decision makers on PPPs. When asked about measures used to protect the public interests, only one state (of 26 respondents) indicated that public access to information related to a PPP proposal was not important, whereas six states indicated this measure to be not applicable in their PPP process. Opinion/Comment from “Other Individuals/Interest Groups” Survey: The private entity needs to be held to the same standard of access to documents and information as a state DOT would be and implement full, effective public engagement methods.

25 practice was actually the cause of a transparency issue in the case of The Canada Line. Siemiatycki (2007) reviews the confidentiality maintained during the tendering process of the extension of Vancouver’s urban rail system by obtain- ing original technical, financial, and planning documents after bidding had ended. Using standards developed by the Australian National Audit Office (2001), he found that the tendering process followed, and in some case exceeded, best practices for maintaining confidentiality. These practices included withholding select technical and financial infor- mation from public scrutiny during the competitive tender process, releasing entire evaluation reports at the conclusion of the procurement process, and commissioning a series of independent reviews from consultants and a former Auditory General of British Columbia. Siemiatycki concludes that despite these attempts at transparency, resulting public and elected public official dis- satisfaction with one of the chosen implementation methods could have been alleviated by: (1) appointing an independent information commissioner to hear cases for and against dis- seminating information to the public, (2) sharing all infor- mation with elected officials so that they may better decide whether to approve or reject a project, and (3) requiring a government auditor general to certify that each summary report released throughout the project procurement repre- sents the full range of issues contained within the full length document. Jeffers et al. (2006) similarly recommend that an indepen- dent process auditor ensure that all necessary legal, account- ing, business plan, and policy issues are addressed from the development of a PPP proposal through the final bid accep- tance. Furthermore, states need to develop in-house capabili- ties to negotiate with, and oversee the operations of, private sector partners (Jeffers et al. 2006; Oberstar and DeFazio 2007). Non-in-house auditors and consultants may potentially have clients on both sides of an agreement and therefore may have conflicts of interest. The complexity of a PPP can make it easy to hide true costs and benefits related to a project from the public (Bloomfield 2006). One of the true ‘innovations’ brought on by lease–purchase agreements is that payments made to the contractor are treated as operating expenses rather than capital expenditures. Thus, the public sector can enter into long-term leases without obtaining voter approval, maintain compliance with statutory debt limits, and avoid reporting long-term lease obligations as debts. These “off-budget” or “off-balance-sheet” financing methods avoid restrictions on debt, but do not avoid debt itself. Bloomfield recounts an example in Plymouth County, Massachusetts, in which misleading language suggested to the public that a private investor was paying for a new correctional facility, whereas tax payers were required to pay the entire project cost. Exam- ples such as this underscore the need for government to make the PPP process as transparent as possible to the public. A PPP delivery system is characterized by a multistage process for contractor’s selection (expressions of interest, con- tractors’ qualifications, proposals, and best offer and nego- tiation), a multi-criteria evaluation process for contractor’s submissions for each stage, and an agreement that generally covers all project phases of design, construction, and oper- ation (Abdel-Aziz 2007). Because this method seeks more innovation from private partners, those partners have more intellectual property to protect, and thus transparency is necessarily lessened. Although public scrutiny of decision-making is impor- tant to accountability of government spending, all rationales for maintaining confidentiality during the proposal process relate to ensuring a competitive tendering process that pro- vides private bidders with incentives to deliver innovative designs for the lowest possible cost (Siemiatycki 2007). In the USC study, Buxbaum and Ortiz (2007) suggested that the public sector should be clear and up front about what type of information should remain confidential and provide an explanation as to why confidentiality is necessary during the proposal process. Confidential information, however, could be kept at a minimum to ensure public support. A balance between temporary confidentiality and full disclosure of selec- tion criteria, scoring and agreements was proposed in our interested parties’ survey as a mitigation measure to the concern of transparency. It should be noted that final awards and contracts between the public and private sectors are sub- ject to the state freedom of information acts. Both Victoria, Australia, and British Columbia, Canada, have developed public disclosure policies that are aimed at achieving trans- parency in procuring PPP projects. The guidance developed by Partnerships British Columbia on public disclosure (2007) includes guidance on the level of disclosure by milestone of the PPP process. Best practices have been developed to promote trans- parency in the PPP procurement process (Australian National Audit Office 2001). The International Technology Scanning report issued by Jeffers et al. (2006) similarly notes the impor- tant role auditors play in the procurement of PPP projects. The scanning team’s recommendations include: • Implementing the use of a process auditor position for each PPP project; • Conducting audits throughout the project life cycle, not just of the end construction costs; • Involving internal audit staff and financial experts early in the tendering process to improve the quality of high- way project Request for Proposal (RFP); and • Specifying outcomes desired and allowing contractors the opportunity to determine the detailed specifications to construct, maintain, or operate the project based on the outcome specifics. Although specifying outcomes rather than outputs is a major driver of the innovation found in a PPP, this best

The Virginia DOT has developed a process to review PPP submission that incorporates transparency and public par- ticipation. PPP proposals are reviewed by an Independent Review Panel that is comprised of members from various stakeholder groups. Furthermore, proposals are distributed to affected jurisdictions, and these are provided with a 60 day period to review and submit comments. Transparency is not limited to the procurement process, and it is important that it remain beyond the procurement process, particularly when revenue sharing provisions are included in the PPP agreements (Samuel 2005). The public should have access to annual traffic and revenue information, audited financial statements, and other documents used to determine the toll revenue returned to the public sector. The concession agreements for Chicago Skyway, Indiana Toll Road, and SR 125 in California mandate public disclosure of annual finances and performance (Replogle 2007). Public Participation Any transportation planning exercise involves public partici- pation to varying degrees. PPPs are new, and there are so many misconceptions about how they really work. Therefore, public participation in PPP projects is even more important. The decisions surrounding the long-term lease of the Indi- ana Toll Road to a private concessionaire was the subject of intense debate and controversy both during and after the actual transaction. There are conflicting accounts on how well the public was kept informed about the facts of the trans- action. Some legislature members complained that the deal was done in “secrecy” (GAO 2000b). That the Daniels admin- istration held hearings after formally announcing the lease was also a subject of legislative criticism (Replogle 2007). On the other hand, staff from the Indiana DOT and the Indi- ana Finance Authority who were interviewed for the USC study (Buxbaum and Ortiz 2007) indicated that legislative hearings were held between January and March 2006, as part of the process to create enabling legislation for the Indiana Toll Road concession, and these hearings were open to the public. After PPP legislation approving the deal was enacted, additional hearings were conducted in Indianapolis and in the area where the toll road is located. The perception of a lack of transparency has plagued other recent PPP deals, (e.g., the SH-130 in Texas), but after the public backlash, some PPP proponents and decision makers took notice and are making an effort to communicate and involve the public in the process. In New Jersey, the gover- nor began to explore the feasibility of leasing public assets, including toll roads, eventually moving to pursue an asset monetization through the creation of a public corporation. The study conducted to develop the asset monetization plan was kept “under wraps” for several months, and legislators 26 demanded that the administration make the study public, even resorting to court action, after being denied access to the report. The governor released his plan during his State of the State address in January 2008, and in an effort to gain sup- port, the administration held public meetings in each county to present the plan. Almost 60% of the respondents (26 states) in our state DOT survey consider the lack of opportunities for public input as a “very important” concern. Only 7% (three states) considered this issue to be “not important,” all three of which are not considering highway PPPs. As mentioned earlier, several respondents of our inter- ested parties’ survey included transparency as one of the main concerns and factors to consider in a PPP, citing items such as public access to concession documents, applying the same standards of public disclosure in the public sector to private entities in a PPP, delineation/limitations of what is proprietary information and what is not in the contract, and public oversight at all stages (i.e., from procurement, throughout construction, and operations of facility). According to the recent GAO report on long-term conces- sions (GAO 2000b), both Victoria and New South Wales, in Australia, require transparency in their PPP process, by keep- ing the public informed, as laid out in the public interest cri- teria shown previously in Table 4. Adequacy of Legislative Branch Review The use of PPPs for transportation requires enabling legisla- tion allowing the public sector to enter into agreements with the private sector to provide transportation infrastructure. According to FHWA’s PPP website, 23 states and Puerto Rico have enabling legislation for PPPs. Some states’ legis- lation only provides authority to implement specific projects contained in legislation. For instance, legislation in Indiana specifically approved the Indiana Toll Road concession, and future PPPs in this state will require further legislative approval. Design-build has been used more extensively, with 30 of the 44 states in our survey having used this PPP option, and 36 states indicating that they have considered design- build. Individual PPP proposals must be approved by the leg- islature in Alaska, California, Delaware, Florida, Indiana, Louisiana, Tennessee, and Washington State—about one- third of the states that have PPP-enabling legislation. In some of these states, projects are limited by a specified number of greenfield projects (e.g., Alaska, California, and Tennessee), whereas others only require legislative approval for brown- field concessions (i.e., Florida). Over the last two years, a few high-profile long-term con- cession agreements intensified the debate of PPPs in general, and raised concerns about the extent to which the legisla- tive branches of government have an opportunity to review,

27 understand, and influence PPP deals. Several events of 2007 demonstrate that state legislators are concerned about the speed and transparency of long-term concession contracts: • The Texas legislature imposed a two-year moratorium on PPPs and directed the Texas Transportation Com- mission to accept a new bid from North Texas Tollway Authority for the construction of SH-121, which had been originally awarded to a private consortium; • In Pennsylvania, the legislature moved to enact Act 44 to allow a “public-public” partnership between the Pennsylvania DOT and the Pennsylvania Turnpike Authority, after the governor had issued a request for “expressions of interest” for the potential lease of the Pennsylvania Turnpike; • New Jersey legislators filed a lawsuit against the Corzine administration to make public a feasibility study on the “monetization” of existing toll roads in the state; and • The House Transportation and Infrastructure Commit- tee held hearings on PPP topics, including protecting the public interest, and Congressmen Oberstar and DeFazio issued a letter cautioning states entering into PPP agreements for transportation infrastructure. In contrast to these legislative reactions, our “state DOT” survey found that a significant number of the respondents (18%) considered the concern of lack of time for legislative review or no legislative branch review as “not important” when compared with other PPP concerns from the survey. On the other hand, a respondent of the interested parties’ sur- vey, who represented an interest group that advocates for public interests, proposed that legislatures should not only provide enabling legislation for PPPs, but also approve final concession agreements. Perceptions of Foreign Control of Domestic Assets and the Role of Local Contractors Concerns of foreign control of public assets are based on the impression that allowing a foreign firm to control our nation’s roadways may lead to national security and/or trade agreement issues. This concern has two potential compo- nents: foreign government control versus foreign private firm control. In PPPs, foreign control concerns are mostly related to the latter, although the former could be a factor when dis- agreements over PPPs may affect trade agreements with for- eign governments. Some commentators frown upon allowing foreign com- panies to operate, maintain, or control U.S. infrastructure (Dobbs 2007). In Tennessee, for example, the senate passed a bill (in March 2008) to limit contracting with foreign con- cessionaires. This type of restriction, however, may violate bilateral trade agreements, such as those between the United States and Australia. Because toll roads were developed and operated almost exclusively by government and quasi-government toll author- ities for the last century, non-U.S. companies are now best positioned to finance and operate private toll roads in the United States (Gilroy 2007). For example, Spain has a long history of toll concessions, with enabling legislation dating back to the 1950s, and Spanish companies have a strong presence in toll road concessions in other countries (Izquierdo and Vasallo 2004). Cintra, a Spanish concessionaire, is an equity partner in the Chicago Skyway, Indiana Toll Road, Trans Texas Corridor 35, and SH-130 in Texas, and also led the consortium for the Highway 407 Express Toll Route (ETR) in Toronto, Canada. Another reason foreign companies have flocked to the United States is that they are attracted by the stability of the U.S. government and its legal system that enforces contracts (Buxbaum and Ortiz 2007). Private investors are hesitant to participate when the public partner has poor credit quality or political, legal, economic, and commercial circumstances that are unstable (Zhang 2005). As the United States mar- ket has matured, joint ventures between U.S. and non-U.S. companies (e.g., Fluor/Transurban, Zachry/Cintra, Kiewit/ Macquarie, and JP Morgan/Cintra), and U.S. financial insti- tutions have created multi-billion-dollar infrastructure invest- ment funds (Samuel 2007). Despite increased United States participation in conces- sions, other concerns remain, particularly related to whether local contractors and smaller firms will have an opportunity to participate. The question is whether a private concession- aire will use local contractors for construction work and/or have open bids for other tasks that might be contracted out, similar to current public sector practice. In Indiana, con- struction unions were demanding that the concessionaire sign a labor agreement to give 95% of the contracted work to trade unions, based on their estimated share of contracts before the Indiana Toll Road lease (“Unions Want Indiana Toll Road Jobs” 2007). The concessionaire indicated that no such deal would be signed. The concession agreement, however, requires that at least 90% of the concessionaire expenses be awarded to companies in Indiana, and it also sets goals for minority business enterprise and women busi- ness enterprise participation (“ITR Concession Company Contracting Goals Are Being Met” 2007). Organizations related to the construction industry, such as the National Asphalt Pavement Association, the Associated General Contractors of America, and the American Road & Transportation Builders Association, have stated their sup- port for PPPs as one tool to pay for infrastructure, among other funding and financing options. Foreign control of domestic assets was an important concern for 75% of the state DOTs that were surveyed (33 states). The Canadian respondents, however, were less concerned, with 60% (three provinces) reporting that this

was not important. Of all the concerns evaluated in the sur- vey, this is one of few that received the highest response of “not important.” On the other hand, the opportunity for local contractors and consultants to participate in PPPs was considered an important concern by most states, with only two negative responses. The latter came from states that are not consid- ering PPPs. National Security Concerns After the events of September 11, 2001, the concern about national security and the call for protecting this country has become one of the top priorities of the government. Some critics of PPPs have raised concerns about the for- eign origin of concessionaires and the possibility that this may be a threat to national security. During the Indiana Toll Road deal, opposition to the lease was fueled after public disclosure that the U.S. ports were operated by a company owned by the government of Dubai (Buxbaum and Ortiz 2007). Although there was no direct relation between these two deals, the latter served to strengthen and raise additional concerns about leasing the toll road to for- eign investors. It should be noted that foreign investments in highways that could affect national security are subject to review by the Committee on Foreign Investment in the U.S., under the Foreign Investment and National Security Act of 2007. The “non-DOT” survey brought up the national security concern as well by one respondent, specifically in defining what entity will have final oversight and decision making on PPPs, whether it is the public sector or the private concessionaire. The GAO (2000b) found that the federal government’s involvement with PPPs has been limited to projects that have used or will use federal funding; however, some of these deals may have impli- cations of national interest, such as interstate commerce or national security. The GAO recommended a reexamination of federal programs that will include a definition of national interests on PPP and how these interests can be protected. International Trade Agreement Concerns PPPs can raise international free trade issues. According to a website maintained by Cornell University (http://government. cce.cornell.edu/doc/reports/freetrade), state and local gov- ernments are concerned about losing some of their authority because federal law preempts state and local law where there is a conflict. Furthermore, under free trade agreement regula- tions, foreign investors “have a right to bring nations into international arbitration to defend government measures that affect their investments (property) negatively” (Gerbasi and Warner, n.d.). Literature addressing this concern in particu- lar was found from the Canadian Council for Public-Private Partnerships. The Council, an organization that supports PPPs, published the “Public-Private Partnerships and Trade 28 Agreements: Guidance for Municipalities” in 2003 to pro- vide general guidance and information on the subject. It should be noted that there may be trade principles and treaties that bar discrimination against foreign investors, and such discrimination could be quite disruptive to many sectors of the economy. An example of the potential conflict of trade agreements related to highway PPPs comes from the Highway 407 ETR in Toronto, Canada. As part of the political campaign in 2003, the liberal party promised to reduce tolls on this pri- vately operated facility. The government brought the case to court and arbitration several times, but the court always ruled in favor of the concessionaire, who had contractual rights to set and increase toll rates. In addition, the dispute between the government and the concessionaire for 407 ETR escalated over time with several other issues, and included an attempt by the concessionaire to compel the Registrar of Motor Vehicles to deny vehicle plates and permits to drivers with outstanding toll payments. Both parties reached a set- tlement on all their issues in spring 2006. However, during the dispute period, the government of Spain threatened to veto a trade agreement if the government of Ontario contin- ued interfering with the 407 ETR concessionaire’s right to control tolls (Redlin 2004; TollRoadNews, various articles). Of all our state DOT survey respondents (including U.S. DOTs and their Canadian counterparts), about 29% consid- ered trade agreement implications to be “not important,” all of which came from U.S. respondents. Over half of the respon- dents considered this concern to be “somewhat important,” including all five Canadian agencies. TERMS OF PUBLIC–PRIVATE PARTNERSHIP AGREEMENTS Many of the public concerns related to PPPs are mainly related to the loss of public control over the facility, and whether the contract clauses adequately protect the public interest. PPP agreements include hundreds of pages of con- tract terms and standards that should be met by the conces- sionaire, and are developed to best address risk and the interests of both parties entering into the agreement. And, as the public sector builds experience in PPPs, many of the issues experienced in early PPP agreements become “legacies of the past” (Buxbaum and Ortiz 2007), which are reflected in the use of more “limited-compete” instead of “non-compete” clauses (see the section on Non-Compete and Other Unantic- ipated Event Provisions later in this chapter), or revenue shar- ing as opposed to a one-time up-front payment. Furthermore, PPP agreements include performance requirements and/or specifications that must be met by the concessionaire. Asset Control and Ownership In a PPP, the facility remains under ownership of the public sector; however, certain responsibilities are transferred to the

29 private partner, as specified by contract (Samuel 2005); these responsibilities revert back to the public sector once the con- tract expires. Regardless of this, however, there is a tendency to equate a PPP with complete “privatization” (Samuel 2005; Baxandall 2007), especially on very long-term deals. There was a consensus among the states surveyed that asset control is an important issue, with more than two-thirds of the states surveyed rating it as “very important.” The GAO and U.S. Public Interest Research Group reports on PPPs, and responses from our interested parties’ survey identified the concerns on asset control and ownership: • Toll rate setting, where toll rate changes do not require public sector approval. This includes annual increases and maximum rates allowed by contract, and public sector inability to modify toll rates for transportation network management. • Non-compete clauses (such as those included in the SR-91 in California concession agreement) that pre- vented modifications to the leased asset or to competing facilities, or limited-compete clauses that allow mod- ification and/or construction of competing facilities, albeit at a cost. This could include implementation of regional or state transportation plans to accommodate changes over time. • Some PPP agreements may create a “tax” on normal policy making, by including compensation clauses that require the public sector to pay the private partner for any revenue losses as a result of transportation improvements sponsored by the public sector. • Safety and maintenance standards. Inability to guaran- tee state-of-the-art safety and maintenance standards on the leased facility. These can always be included in a contract, but represent an additional cost that will affect the cost or valuation of the facility. • Project oversight. Reduced ability to control various aspects of transportation asset management, from con- struction to maintenance and operations. These asset control and ownership issues are major elements in the formulation of PPP contract terms and are discussed in more detail in the subsequent sections. Tolling Policy Highway PPPs are paid for either with direct user fees (such as tolls), government payments (generally from taxes or other general revenues), or both. Most government entities in the United States are struggling with the ability to keep the cost of developing, operating, and maintaining highway infrastructure under control, and also find it difficult to raise either general purpose taxes or motor fuel taxes. Recent sur- veys have found that there is higher support for the “user pays” concept of tolling than for taxes (Zmud and Arce 2008). Overall, more than two-thirds of our DOT survey respon- dents considered the toll setting policies related to PPPs to be a “very important” concern; however, a significant share of the respondents (18%; i.e., six states and three Canadian provinces) still indicated that it is “not important.” The PPP debate, specifically related to long-term conces- sions paid through tolls, is caught in the middle of a debate about tolling policy. In the past, most toll authorities acted on a toll policy (not necessarily explicit) of keeping tolls as low as possible to meet debt obligations on a toll facility or sys- tem of facilities. Toll increases were typically done as a last resort, and only after much agonizing public debate—similar to debates on transit rate increases. Unlocking the value of a transportation asset actually means allowing toll rates to be set at market levels and/or permitting them to increase in accordance with inflation, and leveraging that future revenue stream into up-front cash. When tolling as a revenue source and PPPs as a project delivery mechanism are pursued at the same time, toll rate setting control appears to move from the public sector, where elected officials are accountable, to private companies that are motivated by rates of return. Both the Chicago Skyway and Indiana Toll Road long-term con- cessions were done with the explicit purpose of increasing the asset value of the project through taking rate setting con- trol away from politically motivated officials. The contract terms for both of these agreements allows for toll increases well above increases that have generally been seen in the United States, and elected officials no longer have the ability to intervene in toll increases that are within the caps specified in the contracts. Opinion/Comment from “Other Individuals/Interest Groups” Survey: In light of the fact that we can’t just raise tolls, the P3 is the next best answer. Indeed, the concept of “unlocking the trapped asset value” of transportation assets has been used as a key argument in favor of PPPs (Gribbin 2006; Replogle and Funderburg 2006). By moving to PPPs, elected officials are removed from the mix on individual toll rate setting decisions in legally binding contracts (although they do approve the over- all structure allowing for future increases). This added value can then be used for a variety of public projects, in addition to providing a profit for the private concessionaire. Allowing toll rates to escalate does increase the value of the transportation asset, but this is a public policy decision that arguably should be separate from the decision to pursue PPPs (Buxbaum and Ortiz 2007). However, this is not clear because the public sector has historically been unwilling or unable to raise tolls, derailed by political debate or popular disquiet (European Commission 2003; Gilroy 2007). The Florida Legislature has attempted to reverse this trend by passing a provision that requires annual toll rate indexing by

Consumer Price Index (CPI) no less than once every five years (Buxbaum and Ortiz 2007). Responsibility for setting tolls depends on the nature of the partnership. Long-term lease agreements, otherwise known as concession agreements, have received a great deal of attention because they allow the concessionaire to set the tolls. Public control of toll setting policies is established within the contract and typically includes toll growth caps that cannot be exceeded by the private concessionaire. PPP- enabling legislation could include toll setting policy that has been agreed on by decision makers, and with public input (Buxbaum and Ortiz 2007). Some suggest that the private sector cannot be trusted to raise tolls because it will do so inordinately to maximize profits. The private sector will set tolls based on market factors, which will be highly correlated to the level of com- petition from alternative facilities or modes (GAO 2000b); therefore, if competition is limited, the private sector may set toll rates within the allowable maximum rates by contract, and yet realize revenues that exceed the cost of the road and a reasonable rate of return. The concern is that besides goug- ing users, the private sector may be taking money that could be going to the public agency. Some suggest that it is not always in the best interests of private partners to raise tolls by the maximum allowable amount if it drives some users to alternative routes, thus eroding profits (Samuel 2007). Careful contract negotiations can constrain maximum toll increases. The recent National Surface Transportation Policy and Revenue Commission report recommended capping toll rate increases at the level of the CPI, adjusted by produc- tivity. Tolls on the Indiana Toll Road are scheduled by the Indiana legislature through June 2010. Thereafter, maximum annual increases for all vehicles are capped at the greater of 2%, CPI, or per capita nominal growth in gross domestic product (GDP). Tolls on the Chicago Skyway are scheduled in the lease agreement until 2017, with maximum annual increases capped at the greater of 2%, CPI, or per capita nominal GDP growth beyond 2017. Tolls on the Pocahon- tas Parkway in Richmond, Virginia, are specified until 2016, and annual increases are capped at the greater of 2.8%, CPI, or per capita real GDP growth thereafter (Subcommittee on Highways and Transit 2007a). Real GDP growth over the last 10 years has ranged between 0.8% and 4.5%, whereas CPI has fluctuated between 1.5% and 3.4%. The recent economic forecast from the Congressional Budget Office (2008) esti- mated long-term CPI growth at 2.2% and real GDP growth at 2.3%. However, Replogle (2007) cautioned Congress against setting toll rate caps that may limit or impede the application of value pricing to maintain free flow operations, which is in line with environmental objectives. In the case of the 407 ETR in Ontario, Canada, the long- term concession agreement specifies toll rate increasing at inflation plus 2% over the first 15 years of the concession, and then increasing at the rate of inflation only thereafter. In 30 reality, toll rate increases in the 407 ETR have exceeded the growth rates established by contract. For instance, in 2008, the rate for off-peak travel went from 16.8 cents/kilometer to 18 cents/kilometer, a 7.1% increase. By December 2007, the rate of inflation in Canada, according to statistics from the government of Canada was 2.4%. Therefore, the actual growth rate over the last year was significantly higher than the growth rate allowed by contract (e.g., 2.4% inflation + 2% = 4.4%), following a trend of excessive increases (compared with con- tract specifications) for several years. Toll Setting Is Not Always About Profit User tolls are said to lessen social inequities related to who pays and who benefits by charging drivers for the actual use of highways, tunnels, or bridges. User charges normally are set to recover the cost of the road project and maintain the predetermined operating condition of that road and are high enough to allow for the private partner’s return on investment (Jeffers et al. 2006). Although user fees and congestion pric- ing schemes are often favored by economists as a way to manage demand, Congressmen Oberstar and DeFazio (2007) asserted that tolls are regressive because they charge drivers of all income levels the same amount and suggest that elec- tronic toll collection technology can reduce or eliminate tolls paid by low income drivers. The RPA (2007) suggests con- sidering the effect to middle- and low-income groups when developing the toll-increase schedules, such that these groups are not disproportionately affected. PPP legislation and/or concession agreements may in- clude provisions setting toll rates lower than required to support financing; however, in exchange, the public sector would provide funding or subsidies to attract private sector participation. In Chile, the public sector establishes the maximum toll rate, and the evaluation of PPP proposals takes into account the proposed toll rates, among other fac- tors (Izquierdo and Vasallo 2004). Similarly, some PPPs in Australia have been awarded to bidders that propose oper- ating the facilities with the lowest toll (GAO 2000b). Six- teen of the states with PPP-enabling legislation already allow the combination of public sector funding with private funding on a PPP project (FHWA PPP enabling legislation survey 2007). Shadow Tolls and Availability Payments Direct user fees are not the only way that private concession- aires can be compensated. With shadow tolls the govern- ment pays the private partner to operate and maintain the road based on throughput of vehicles on the highway, which means that the private partner shares in the risk of how many people actually use the highway. In the case of availability pay- ments, payments made to the private partner are directly related to performance standards stated in the contract, and all demand risk is allocated to the government. Both options provide incentives for the private operator to maintain the facility to high standards. In the case of the shadow tolls, if

31 maintenance standards decline, fewer cars will use the road and government payments will decline. However, with this model, the private partner also assumes financial risks caused by other declines in demand. Both methods drive innovation and competitive costs because they allow the private partner flexibility in design and approach. Instead of having to comply with materials stan- dards used by the agency, performance-based specifications focus on the outcome of the end product. Performance speci- fications are established for each element of the asset and then clearly defined as to the minimum acceptable performance level and response time to fix deficiencies (Abdel-Aziz 2007). Availability payments/shadow toll agreements can also be designed to meet environmental objectives, by rewarding greater mobility and reduced congestion, which minimize emissions and fuel consumption (Replogle 2007). Shadow tolls are widely used in Europe; however, there are indications of a move to more transparent methods of direct user charges there. Private financing of roads and bridges paid with shadow tolls or availability payments does not provide new revenue and does not create a relationship between who pays for the improvement and who gets the benefit (Jeffers et al. 2006). Shadow toll payments in Europe typically come from general funds. In British Columbia, Canada, the Golden Ears Bridge will combine real tolls with availability payments. TransLink (public partner) will collect toll revenues that will be used to compensate the DBFO concessionaire through avail- ability payments that have been established by contract. The Port of Miami Tunnel, a 35-year PPP agreement, will be financed through annual availability payments that will be indexed annually for inflation. The availability payment will be reduced if the tunnel is not open to traffic or other major performance measures are not met by the private oper- ator. Although still in the negotiation process, the concession was awarded to the private investors who offered the lowest availability payment of $33 million (in 2007 dollars), com- pared with the public estimate of $55 million. As PPPs continue to evolve in the United States, availabil- ity payments may become more common, as suggested by more recent deals. The public sector retains the demand risk, and it requires additional performance monitoring that should be accounted for as an additional cost to the public sector. Opinion/Comment from “Other Individuals/Interest Groups” Survey: Our experience with availability payments has been extremely positive . . . Emphasis could be given to institu- tionalizing the P3 process and providing the necessary training to make P3 part of the everyday toolkit for project implementation. Private Sector Toll Setting and Diversion Impacts A private firm operating a single highway may not consider the network effects of its road pricing. Its toll schedule may be set up to maximize profits, but this can move traffic to other roads, costing municipal and state governments more in the long run as a result of increased local congestion and damage done by trucks to local roads (Regional Plan Associ- ation 2007). Also, given that the toll setting rights are trans- ferred to the private sector, the public sector is restricted from controlling the effect of traffic diversions into public roads, and would not have the power to reduce tolls to restore “nor- malcy” in other parts of the highway network. Past experi- ence shows that significant toll increases will divert traffic, as was the case in New Jersey and Ohio, where toll increases were eased because of significant truck traffic diversions into local routes. Several attempts have been made to quantitatively study the relationships between toll increases and traffic diversion that might come about from PPP projects. Belzer and Swan (2008) construct a regression model to demonstrate the diver- sion effects of private companies setting tolls based on profit maximization policies. Using historic data along the Ohio Turnpike, the research suggests the existence of toll rates that would simultaneously maximize private profit and shift a significant number of cars and trucks to alternate compet- ing routes. Diversion to these competing routes, many of which are non-limited-access, could pose significant safety hazards and maintenance costs to the road system overall. Although not necessarily questioning the wisdom of pricing, the authors suggest allowing private operators to control individual roads will erode system performance overall, create economic inefficiencies (deadweight), and curtail inter- state commerce. In Oklahoma, opposition to a toll bridge PPP led residents near the proposed location for the bridge to take the case to court on the grounds that the public did not vote on the pro- posal and there were no open bids. One of the main concerns of this group was that the surrounding infrastructure could not handle potential traffic growth. The court struck down the project, although not for these reasons, but because the alignment for one of the bridge approaches fell outside the toll authority jurisdiction (“Municipal Toll Roads Become Likely Path” 2008). States are aware and recognize the importance of this concern, as expressed through the state DOT survey. All respondents indicated that the impact of PPPs on the overall transportation networks was important. Non-Compete and Other Unanticipated Event Provisions PPP contracts typically provide protections of the future revenue stream when tolls are the finance mechanism. In

addition, addressing other unanticipated events is also a key element of any contract, including a PPP. Non-Compete Clauses Non-compete clauses limit improvements the public part- ner can make to nearby facilities so that demand for the PPP facility is not eroded. A more appropriate name for such clauses may often be “limited compete” if they do not ban improvements outright, but contain negotiated provisions for remedies. By limiting competition, the up-front value of a concession would increase; therefore, this becomes a trade-off consideration for decision makers. Non-compete clauses are often cited by PPP critics, who object to tying the hands of government to deliver needed transportation improvements, and most states in our state DOT survey agreed that this is an important concern. The most-cited example of the dangers of non-compete clauses in the United States is California’s SR-91. In the non-compete clause, the California DOT agreed not to make improve- ments within one-and-a-half miles of the HOT lanes on SR-91 without consulting the private operator, California Private Transportation Company (CPTC). In 1999, when the California DOT sought to add merging lanes to the existing free lanes for safety reasons, the CPTC objected. This objec- tion raised public opposition and ultimately led to a lawsuit seeking nullification of the non-compete clause. In 2003, the Orange County Transportation Authority purchased the toll lanes from CPTC for $207.5 million and the non-compete clause was eliminated (U.S.DOT 2004; Subcommittee on Highways and Transit, House Transportation and Infra- structure Committee 2007a). Other instances have been cited in Australia where the public sector has been unable to improve toll-free routes owing to similar agreements. In 2006, one concessionaire convinced the local government to close several competing local roads to through traffic to force drivers to use the tolled facilities, which were lagging traffic and revenue expecta- tions (AECOM 2007a). As a direct result of such cases, Congressmen Oberstar and DeFazio (2007) suggested avoiding non-compete clauses alto- gether. The 2005 federal SAFETEA-LU transportation law Section 1604(c) bars states from including such non-compete agreements for the Interstate System Construction Toll Pilot Program (Regional Plan Association 2007). Samuel (2007) agrees that earlier approaches such as SR-91 were flawed, but asserts that non-compete agreements are necessary in some sit- uations to protect private partners from unfair competition aris- ing from government subsidies. Most recent agreements include “limited-compete” clauses, generally allowing public partners to build everything in its current long-range trans- portation plan. Future roadways a state might build that are not in its existing plan and that do fall within a narrowly defined 32 competition zone, may be compensated for using a formula for any damage done to toll revenues. Recent deals have included such limited-compete clauses. For example: • The Pocahontas Parkway includes a 6 mile non-compete zone, whereas the Indiana Toll Road agreement defines a 10 mile competition zone in which the state could pro- vide compensation for projected loss revenues from building a new four-lane limited access highway, but can build anything else along the corridor (Buxbaum and Ortiz 2007; Samuel 2007). • Denver’s Northwest Parkway concession agreement requires the public authority to compensate the conces- sionaire if road or transit projects not already planned are built in the corridor and cause a loss in revenue. If the authority cannot pay, the concessionaire may keep revenue sharing money, increase tolls beyond set limits, or extend the lease (“Northwest Parkway Set to Close in October” 2007). • The concession agreement for the CityLink in Mel- bourne, Australia, allows for compensation if a new project takes away traffic from the facility, either through cash or contract extension. Transurban has filed a $36 million claim for the construction of the Wurundjeri Way, and is contemplating filing another claim if the government proceeds to build a new east– west toll tunnel (Millar 2007). The Chicago Skyway agreement is the exception in which no “non-compete” clauses were included in the lease agree- ment. However, the urban nature of the corridor makes it very difficult and costly for the public sector to make capacity improvements on parallel, competing facilities (Samuel 2005). Contract terms also regulate the roles of the public and pri- vate sectors as a result of unanticipated events. For exam- ple, in Portugal, concessionaires are compensated for revenue losses owing to “force majeure” (Izquierdo and Vassallo 2004). Use of Proceeds and Revenue Sharing Several projects, including the Indiana Toll Road and the Chicago Skyway, yielded large up-front payments to govern- ments by concessionaires in exchange for the right to operate transportation facilities. Proceeds from the Chicago Skyway concession were largely spent on repaying debt, creating a trust fund, and funding public social initiatives. Proceeds from the Indiana Toll Road were used to repay debt and fund the state’s ten year transportation plan (Subcommittee on Highways and Transit, House Transportation and Infrastruc- ture Committee 2007a). However, both deals have raised con- cerns regarding proper valuation of concession deals, the trade-offs between up-front and long-term payments, and who benefits and who pays (Baxandall 2007; Enright 2007).

33 The aforementioned concession deals transferred toll col- lection and road operations for 75 to 99 years to the private sector. Although the money has been used to meet immedi- ate financial needs, and the repayment of debt benefits the government in the long term, the reality is that future gener- ations might be paying for benefits that were substantially realized in the early years of the concession. On the other hand, up-front payments could also be invested in capital projects that may have a useful life beyond the term of the deals and generate public benefits over the long term. Use of Proceeds Large up-front concession fees, typical of brownfield conces- sions, are popular with politicians managing governments in financial difficulties (Thornton 2007). They provide a bud- getary windfall that can be spent flexibly on any public pur- pose, transportation or otherwise (Brown 2007). Besides paying down debts and funding social programs, $500 mil- lion from the Chicago Skyway deal placed in a “rainy day” fund is earning $25 million annually, as much as the city used to earn from operating the Skyway itself (Thornton 2007). Applying proceeds in such ways can be seen as fiscally respon- sible ways of improving a city’s credit rating and risk assess- ment. It is also possible to have the proceeds come as an annual rather than up-front payment. Although this appears to be an option, no specific examples were found through the literature review of PPP deals where the public sector is col- lecting annual payments from a concessionaire. A policy brief on greenfield PPPs from the Reason Foundation (Gilroy et al. 2007) indicated that this type of concession arrangement has been used in Europe. Fitch Ratings, however, noted the need to match invest- ment decisions made today with long-term sustainability of transportation. Fitch considers the choice of high up-front payments a risk to the government’s fiscal position, as it may limit its flexibility to meet future transportation needs. However, Fitch positively assesses deals that generate large up-front payments “if proceeds are invested in comparable long-term assets that provide lasting economic benefits.” Conversely, it will view negatively “the use of proceeds for short-term operating needs of the government” (Fitch Ratings 2006; Checherita and Gifford 2008). The use of the proceeds is an important consideration, and most observers agree that it could be used for transportation; otherwise, government would be taxing future infrastructure for general needs today. Buxbaum and Ortiz (2007) recom- mended that decision makers consider debt service, trans- portation programs, and reserve funds as potential uses for concession proceeds, and that if revenues are used for non- transportation uses, decision makers should make a case for the relationship between the source and the uses of funds. In addition, the study suggests that funding could be allocated to projects that benefit the users of the lease facility and find mechanisms to ensure that projects can be funded over the life of the lease. By investing up-front or recurring revenues in capital projects, particularly from brownfield concessions, the public receives the benefit from other system improve- ments by monetizing the future revenue streams of an exist- ing facility. Replogle (2007) recommended that surplus revenues (specifically in toll-managed lanes) be used for transit and impact mitigation. PPP-enabling legislation in 12 states prohibits revenues from being diverted to the state’s general fund or for unrelated uses. According to our state DOT survey, most states (exclud- ing five respondents) consider the use of up-front proceeds to be an important concern. The Pennsylvania Turnpike valua- tion analysis by Foote et al. (2008) raised the concern that under a PPP agreement, up-front revenues from leasing the Turnpike might be redirected for non-transportation uses (such as budget relief), because there are no constitutional or statutory protections that could prevent such action, although the reason for considering a long-term lease of this facility is to provide much needed transportation funding. In Virginia, any up-front payments are to be used in the project corridor. The appropriate amount that up-front payments should be is also difficult to calculate. Assumptions regarding discount rates, travel demand, or maintenance schedules may have a profound impact on the value of the project. The value of the facility is also driven by the length of concession, toll rates and toll increase assumptions, private equity, and risk. Some commentators are concerned that the public sector may be achieving less value than it should for its capital infrastruc- ture (Baxandall 2007; Enright 2007). For example, there are several instances in Europe of private partners earning so-called “super profits”—profits that grossly exceed the expected profits projected in the orig- inal contract (Jeffers et al. 2006). Such profits can result from unanticipated demand and windfalls from refinancing debt. To remedy this, European countries and some Australian states generally include a clause in PPP contracts that requires shar- ing of any refinancing profits that may otherwise provide windfall profits for private partners. In the case of TIFIA loans (a type of federal government subsidized loan), profits from refinancing could be used to expand or complete the project for which the loan was issued (Hedlund 2007). However, revenue sharing related to refinancing may not be appropriate in some contracts, because the value of the refinancing may have been included in the initial valuation analysis (GAO 2000b). In the case of the Chicago Skyway, equity was reduced after refinancing, but, according to an investment banker involved in the deal, no refinancing gains were realized, because this had been assumed in the financial offer to the city (GAO 2000b). Profit can be difficult to measure, because this involves delving into the detailed accounting practices of companies that may have many lines of business and/or a portfolio of toll

projects that they spread management expenses among. In response, European PPP sponsors suggest structuring profit- sharing models based on revenue rather than profits because revenue is easier to monitor. They also suggest incorporating contract clauses that allow for the review of the concession contract clause every 7.5 years (Jeffers et al. 2006). Rebal- ancing provisions, which bring the contract terms back into the financial balance achieved in the original negotiation, are currently used in Spain and Portugal (Izquierdo and Vasallo 2004; Mayer 2007; GAO 2000b). Revenue Sharing Revenue sharing usually comes at the cost of a lower up-front payment. But, the public sector does benefit from future profit- sharing revenue, which can offset the reduction in up-front payment. A respondent in our interested parties’ survey rec- ommended the provision of policy that allows for sharing of upside revenue on toll lease (particularly for “brownfield”), and that such policy should be flexible enough that it can be tailored for each individual project. Texas’s State Highway 130 and Virginia’s Pocahontas Parkway PPPs provide exam- ples of revenue-sharing agreements. Both include tiered rev- enue sharing that depend on the equity return and internal rate of return of each of the projects, respectively (AECOM 2007b). However, given the high return thresholds, it is unlikely the public partners will share significant revenues under these agreements (Page 2008). 34 paying customers, where tolls are involved. However, the public sector needs to be vigilant that the standards are being adhered to (Buxbaum and Ortiz 2007). Hand-Back Provisions At the end of the concession, the O&M of the facility, along with the right to collect tolls (if any), reverts back to the public sector. It is in the public interest that the facility is returned in good condition, preferably requiring none to minimal public investment. The PPP contract terms could specify the condition at which the facility must be returned to the public, and may include penalties to the private sector for not meeting these requirements. Opinion/Comment from “Other Individuals/Interest Groups” Survey: There should be strong consideration for policy provisions that require the governmental entity to share in the upside revenue on the lease of toll roads. This should not be overly prescriptive, but give the flexibility needed for each state to work within an overall policy and then apply this based on the specific situation. Opinion/Comment from “Other Individuals/Interest Groups” Survey: Not clear whether the private lessor will exercise good stewardship for the facility. When the lease is up, in what condition will the facility be returned to the public? For example, hand-back requirements in the Port of Miami agreement include a hand-back reserve, which is built annually in the later years of the concession term. The hand-back reserve is used to ensure that the facility is turned over to the Florida DOT in top condition. Failure by the concessionaire to provide annual deposits to the hand-back reserve will result in deduc- tions to the annual availability payments (Clary 2008). The PPP agreement for the I-495 HOT lanes in Virginia requires the concessionaire to provide a letter of credit or per- formance bond that can be used by the Virginia DOT if the hand-back requirements are not met. A PPP contract with heavy emphasis on performance standards for compensation could also protect the public interest by ensuring that a specific condition is maintained on the facility throughout the full con- cession term. In the United Kingdom, the Highway Agency retains 40% of the payments during the last five years of the concession, and disburses the payment to the concession- aire once it determines that the facility has been returned to the government in good condition (Izquierdo and Vassallo 2004). Environmental Safeguards A PPP can potentially raise, but must not be permitted to lower, environmental standards for highway operation. In late December 2006, the Sierra Club and other groups spoke out against a potential PPP in New Jersey because environmental standards might not have been sufficiently met by the private sector. In that case the organization was concerned that the operator would choose to use less expensive de-icing prod- ucts that damage the environment (Regional Plan Association 2007). Other environmental considerations included the effect Maintenance Standards and Hand-Back Provisions Maintenance Standards PPP contracts, especially those that transfer O&M for a period of time to the private sector, will have extensive terms related to maintenance standards. The goal of the public sec- tor could be to ensure that the leased facility meets or exceeds these standards, and that these standards are in line with the public interest. In addition to these legally binding obliga- tions, the private partner will have other interests in keep- ing up with maintenance needs, because these provide the best long-term return on their investment—small maintenance costs now can avoid larger repair bills later. Also, extreme neglect will lead to the facility being less attractive to toll

35 of congestion and emissions on the environment. In his testi- mony to Congress in May 2007, Replogle, representing the Environmental Defense Fund, expressed support to PPPs and tolls, as long as these are used to better manage demand and promote alternative transportation modes and environmentally sound behavior. Performance-based contracts that compensate the concessionaire for providing free-flow service and meet- ing environmental goals, variable toll rates for traffic manage- ment, and the use of revenues to support public transportation are some of the strategies presented in his testimony. PPP contracts can make environmental performance stan- dards enforceable as part of the environmental approvals process, as well as through incentive-based methods such as performance bonds, funding set-asides, and enforceable contingency measures (Regional Plan Association 2007). Other strategies used to address environmental issues in PPPs include: • Holding regular meetings with local community groups during both construction and implementation phases to identify and mitigate construction-related impacts and operational impacts once opened; • Negotiating agreements with major opposition groups and including environmental mitigation conditions in the concession agreement, such as the use of noise- reducing asphalt; • Conducting comprehensive environmental studies before plan development including extensive public outreach and stakeholder communications; and • Integrating environmental mitigation and improvement mechanisms early in the preliminary design process (AECOM 2007a). Oberstar and DeFazio (2007) warned that states should not turn to privately financed projects to avoid meeting environ- mental requirements that come with federal funding. Most states in our survey (98%) indicated that environmental safe- guards are very important in PPP contracting. Among other requirements, federal funding forces states to comply with the National Environmental Policy Act (NEPA). In addition to federal requirements, many states have their own environ- mental laws and requirements that should be met for any proj- ect. A respondent of the interested parties’ survey suggested that PPP agreements should not be approved until after the completion of the NEPA process to ensure: • A full, fair, and open planning process for transportation projects; • Adequate consideration of all transportation alterna- tives; and • Unbiased analysis of viable project alternatives and envi- ronmental impacts. FHWA’s Design-Build rule was amended in 2007, allowing states to release requests for proposals and award design- build contracts before the completion of NEPA, but neither final design nor construction can be initiated before the NEPA process is complete. The rule also requires that the design- build contract should include provisions ensuring that all envi- ronmental and mitigation measures identified through the NEPA process will be implemented, and precludes the design- builder from having any decision-making responsibilities in the NEPA process and from preparing the document. The pro- visions in the final rule appear to address the aforementioned concerns related to PPPs and the NEPA process. Environmental risk is typically better managed by the pub- lic sector (GAO 2000b), and as such the public sector typically retains this risk in a PPP. In Texas, for example, concession- aires are not involved in the environmental assessment process, which remain under the responsibility of the Texas DOT; however, this is not always the case. The original investors for the South Bay Expressway (SR-125) in the San Diego area took on environmental risk and had to deal with an environ- mental planning process that took many more years and dollars than what the investors had anticipated, as discussed in the section on Roles of Public and private Sectors, Risk Allocation, and Rates of Return. Labor Relation Issues Labor relation issues are varied among PPP types. In a brown- field concession, labor issues are related to displacement of existing employees, ranging from engineers to administra- tive staff to road maintenance workers and others, including toll operators. Displaced (or potentially displaced) workers will have broad employment concerns including the contin- uation of employment, wages, health insurance, pensions and other benefits, working conditions, and, where applicable, union representation. In a greenfield project these issues are related more to the private sector meeting prevailing wage requirements. PPPs have created significant labor issues in Canada, the United Kingdom, and other European countries, even though it could be argued that the PPP enabled more proj- ects to be built, thereby increasing employment, especially in the construction industry. In the United States, construction unions in Indiana demanded that the Indiana Toll Road’s new operator, ITR Concession Company (ITRCC), provide them 95% of the construction work on the facility. However, ITRCC’s concession agreement does not require it to follow public notification and bidding rules. On the other hand, the concession agreement for the Chicago Skyway, also owned by Cintra and Macquarie (owners of ITRCC), requires all contracts to contain prevail- ing wage language. All contractors are required to submit certified pay vouchers corresponding to a particular job. Thus, the concessionaire can ensure its contractors are following predetermined wages as set by the Illinois Department of Labor (“Unions Want Indiana Toll Road Jobs” 2007). Nonetheless, even with these protections, local and smaller engineering and design firms may be excluded from benefiting from the work generated by a large PPP project, because large

engineering firms can have the design work done in other offices throughout the country, without tapping local resources (KCI Technologies 2005). Also at issue are the potential for less favorable terms of employment in the private sector and the immediate reduction in headcount for those employees who operate the facilities. To resolve these issues, labor protections have been incor- porated into some PPP agreements. Several countries have legislation that specifically addresses the transfer of public sector workers to the private sector with some or all of their benefits (Subcommittee on Highways and Transit, House Transportation and Infrastructure Committee 2007b). On greenfield projects with federal funding, federal labor and contracting requirements (Davis–Bacon act) can address this concern; many states also have “little Davis–Bacon” laws that ensure the prevailing wage for projects. The New Jersey privatization legislation provides compensation for toll road workers (Samuel 2007), guaranteeing employment to union employees for up to six years. However, omitting such specifications from the PPP contract can permit private contractors to reduce staff levels or hire non-union employ- ees, reducing costs, increasing private profits, and increasing the value of the project for the public sector. These benefits, however, may conflict with state labor policies, lead to public disapproval, and could result in potential litigation (Regional Plan Association 2007). In the United States, recent PPP agreements have included contract provisions that address some of the concerns related to workforce protection in both long-term leases of new or existing toll roads. In the Chicago Skyway, the contract required the concessionaire to employ all unionized employ- ees, and employees were given the option to move onto other city jobs. Most of the employees (100 of 105) took other city jobs, whereas the reminder chose to keep their jobs with the Skyway (GAO 2000b). The legislation that will allow the lease of the Midway Airport in Chicago has a range of labor provisions that include requiring the concessionaire to pay employees in line with the city of Chicago wages and bene- fits (Illinois Public Act 094-0750). In Indiana, employees were guaranteed that pay and benefits would not be reduced if they took a job with the concessionaire. About 85% of the employees took jobs with private operator at the same or higher pay, whereas others stayed with the state (GAO 2000b). A newspaper report from November 2007 indicates, however, that promised salary increases have not materialized for toll road collectors, prompting workers to become unionized (Potter 2007). The Texas’ SH-130 lease agreement requires payment of prevailing wages to construction workers in accor- dance with governing law and the concessionaire should meet goals for hiring minorities, women, and disadvantaged business groups. The United Kingdom ensures workforce protection by requiring that new and transferred employees of concession- aires are offered “fair and reasonable” employment conditions (GAO 2000b). 36 Samuel (2007) suggests that workers who are paid reason- able labor-market wages and benefits are likely to be offered work by a private toll company because they have valuable skills and local knowledge. He also noted that government toll authorities are cutting back on staff themselves as elec- tronic toll collection reduces or eliminates toll booths. Private sector groups agree that using local firms saves money and has the added benefit of existing relationships with the public sector (KCI Technologies 2005). Another labor issue relates to the increase in contracting out of services that have been conducted in-house in the past, such as design and oversight of public works. The GAO (2008a) found that the most important factor in a state DOT’s decision to contract out some of these services “is the need to access the manpower and expertise to ensure the timely deliv- ery of their highway program”; cost savings is a secondary consideration. It reported that states protect the public interest through prequalification of contractors and consultants, regu- lar monitoring procedures, assessment of work performed, and standards and requirements for certain types of work. Nevertheless, it appears that state DOTs are still facing some challenges in providing oversight, as they struggle to maintain the required in-house expertise to address demand. This concern was also mentioned in our interested parties’ survey, indicating that as more projects are contracted out, it becomes more difficult for state DOTs to attract and retain talent. In testimony to Congress in April 2007, the Professional Engineers in California Government (PECG), which represents public employees, presented its position on PPPs. The PECG recommends that all construction inspection be conducted by public employees, and that if the public agency is liable for a facility, then the public sector could design, construct, and inspect the facility. Furthermore, PECG indicated in the inter- ested parties’ survey that PPPs should require public oversight, design, and inspection to ensure public safety and cost control. The group claims that design-build has been unsuccessful in California, resulting in higher project costs. Other respondents in the interested parties’ survey brought similar concerns, drawing specifically from the “Big Dig” experience in Boston. The Big Dig had cost overruns, delays, and several issues, including a fatal accident, owing to flawed construction. According to a labor union representative, oversight and enforcement for this project was not properly conducted and there was no demarcation between the public and private sec- tor responsibilities, given that the relationship between both parties was “too cozy.” From the state DOT perspective, most states reported that labor relations are a “somewhat important” concern; six states considered this a “not important” concern. Length of Agreement Long agreement terms, such as the 99 years for the Chicago Skyway, 85 years for the Capital Beltway HOT Lanes, and 75 years for the Indiana Toll Road are a frequent criticism of PPPs, in particular for DBFO or long-term concessions. Our

37 state DOT survey confirms the importance of this concern. Some respondents of the interested parties’ survey suggested concession terms of no longer than 30 to 35 years. A study by Virtuosity Consulting for the OECD and the European Commission of Ministries of Transport on successful exam- ples of PPPs concluded that the optimal concession length is between 30 and 35 years; a concession may be sub-optimal for taxpayers beyond that range (Stambrock 2005). The Chicago Skyway and Indiana leases specified long terms to encourage larger up-front fees. While private opera- tors aim to maximize the length of concessions to safeguard future cash flows, the European Commission (2003) aims to promote open competition and fair market access, reduce the possibility of monopolies, and ensure the public benefit. These objectives would suggest shorter concession agreements. As the experience level has risen, European Union countries have restricted the length of PPP contracts to 21 to 35 years. (Jeffers et al. 2006). The shorter concession terms correspond with the accepted lengths of government bonds, commercial mortgages, and reasonable risk assessments. In addition, sev- eral countries include review and renegotiation of payments every 7.5 years to prevent private partners from earning more than could be earned through other investments given the same risk environment, so-called windfall profits. Some innova- tive procurement methods propose short concession terms (10–15 years), after which the state pays a residual value to the concessionaire, recouping this payment through another concession (Izquierdo and Vassallo 2004). Abdel-Aziz (2007) advises against legislating maximum lengths of concession agreements, maintaining project time- lines could be decided on a project-by-project basis consid- ering unique conditions, whole life-cycle cost, likely term of senior debt, and financial structure. Public and private part- ners, for example, may decide to end the concession once the private debt is retired. A limit on the length of concessions; for example, the 35 years in California’s AB 680 or the 50 years in Texas HB 2702, unless established for specific reasons, might unnecessarily affect achieving the best value for money. The experience in Mexico shows how very short concession terms (maximum of 12 years, and in some cases 5 years) resulted in high toll rates and uncertainty in traffic demand, which led to the failed concessions in the 1990s (Izquierdo and Vassallo 2004). The length of concession agreements will affect the abil- ity of the concessionaire to realize tax benefits from depreci- ation. Although lessees (concessionaires) of toll roads are not owners, if the term of the lease exceeds the remaining design life of an asset at the time of the transaction, the Internal Revenue Service treats the lessee as the owner for tax pur- poses (Subcommittee on Energy, Natural Resources, and Infrastructure 2008). Thus, the lessee may depreciate the por- tion of its up-front payment allocated to tangible physical assets in an accelerated manner over a period of 15 years instead of the entire term of the lease (Subcommittee on Highways and Transit, House Transportation and Infra- structure Committee 2007a). This amounts to a government subsidy to the concessionaire that may significantly reduce corporate taxes if the project proves profitable. Longer- term agreements thus allow the private partner to depreci- ate the asset in the most attractive manner possible and will be reflected in the amount the private partner is willing to pay for the concession (Giglio 1997; Brown 2007). Termination and Buyouts All PPP contracts could incorporate clear terms addressing termination, buyouts, and hand-back provisions, and define the roles and responsibilities of both public and private part- ners if such circumstances arise during the concession period. It is up to the state and its legal advisors to include provisions that protect the public interest. The termination clause of a contract specifies how the PPP contractor will be compensated for work completed if the project or the contract agreement is terminated, depending on the reasons for termination, and any penalty clauses for early termination by the sponsoring agency (AECOM 2007b). The majority of the states responding to the survey agreed that these are “very important” concerns. Performance contracts that commit the private partner to specific results are held to be the key to successful risk allocation, and contractual per- formance guarantees and termination provisions are safe- guards that minimize the risk to the public of long-term contracts (Bloomfield 2006). In the case of bankruptcy, the public sector may step in and take over operations of the facility, or contract with another private entity (Hedlund 2007). It also could allow the conces- sionaire to increase tolls or provide funding to avoid default (Stambrook 2005). In the case of the Indiana and Chicago long-term lease deals, the lenders have the opportunity to “cure the default,” and they could take over the operation of the facility or assign a “successor,” before the state could step in and regain control of the roadway (Foote et al. 2008). Ultimately, whether a facility immediately reverts back to the public sector as a result of bankruptcy will depend on the contract provisions that address this situation. Buyback provisions specify the terms and compensation to the private sector of purchasing the rights to operate the facil- ity before the end of the concession term. Typically, the state would pay “fair value” to the private operator in a buyback situation (Hedlund 2007). The “fair value” is estimated by cal- culating the net present value of net revenues over the remain- ing contract term (Poole 2007). This was the method used to estimate the buyback price for the SR-91 Express Lanes in California. Legislation in Texas (approved in 2007) allows the state to buy back profitable toll roads from private operators, with the buy-back amount based on the original estimates of toll revenues for the life of the project. According to Fitch

Ratings (2006), a buy-back at fair value may lead to higher taxes or high toll rates to support a termination payment, especially if valuations are much higher in the future. Safety and Enforcement Issues In a PPP, the private sector is expected to maintain safe oper- ations of the facility, as regulated by the contract terms. Again, the public is concerned that the private sector will not provide proper maintenance to increase profit, leading to unsafe condi- tions. This argument is countered by the notion that private investors are encouraged to provide safe conditions to attract users (Buxbaum and Ortiz 2007) and to avoid liability. Law enforcement services on highways are typically provided by police and paid by the state DOT or public toll authority. In a PPP these services can still be provided by the state, but paid by the private concessionaire, as was stipulated in the Texas SH-130 contract. Safety concerns also relate to design standards that pro- vide safe operation on these facilities and whether these are enforced and met in a PPP project. The 407 ETR in Toronto has been criticized for adhering to only minimum highway safety standards, not only after it opened to traffic in 1997, but also after it was leased to private investors (Mylvaganam and Borins 2005; Wikipedia 2008). According to the Ministry of Transportation, compared with the 407 ETR, publicly owned facilities typically exceed highway safety standards. Commercial Development Rights The literature review found few references to this topic. In the case of Denver’s Northwest Parkway, Portuguese conces- sionaire Brisa may undertake activities such as commercial development. Rental revenues for two cell phone towers is split with the public parkway authority (“Northwest Parkway Set to Close in October” 2007). The TTC 35 High Priority Trans-Texas Corridor Master Development Plan has provisions for several innovative financing arrangements that involve commercial development rights. These include having the option to lease a parcel or property from an owner to keep the land vacant before actual acquisition, purchase, and lease-back arrangements; license for exclusive or non-exclusive use of a facility; and facility franchises (such as gas stations and convenience stores). 38 The Massachusetts Route 3 North Project was a Design- Build-Operate-Maintain project, financed through debt issued by a 63-20 corporation. Debt service and O&M costs are paid by MassHighway through annual appropriations. The PPP agreement allows the developer to generate non-project revenues through ancillary development in the corridor. The developer receives 40% of the revenue generated through development in the corridor (FHWA PPP website; AASHTO Innovative Finance.org). Data Privacy and Ownership Data privacy and ownership is a concern raised for toll roads, for both privately and publicly operated, especially with the introduction of electronic toll collection, and as such, the con- cern was not further investigated for this synthesis. Toll road users are particularly concerned of the potential for tracking and being able to pinpoint their trips through the facility, as in some cases these data have been released, for instance, as evidence for criminal and civil cases. Liability, Indemnification, and Insurance As any agreement between two parties, PPP contracts will include clauses that define liability, indemnification obliga- tions, and insurance requirements for both the public and private sectors. It is expected that these clauses are crafted such that the interests of each party entering the agreement are protected. The FHWA PPP website describes some of the provisions that limit liability and the indemnity obligations of each party for some PPP projects, including the Chicago Skyway, the Pocahontas Parkway, and Texas SH-130, and the PPP legis- lation survey describes how these are addressed by state. Private investors are concerned about tort liability, because the private sector is not protected by sovereign immunity as is the public sector. The risk of tort liability can be mitigated by using state maintenance and police service, public spon- sorship, and insurance. The latter however can add a sig- nificant cost to the project, affecting its financial feasibility (U.S.DOT 2004). From the public sector perspective, govern- mental liability may not be fully transferable in a PPP, and the public sector may still be subject to lawsuits if deteriorat- ing conditions of the roadway cause any harm to individuals (Fitch Ratings 2006).

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TRB's National Cooperative Highway Research Program (NCHRP) Synthesis 391: Public Sector Decision Making for Public-Private Partnerships examines information designed to evaluate the benefits and risks associated with allowing the private sector to have a greater role in financing and developing highway infrastructure.

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