The economics of large scale infrastructure project finance: An empirical examination of the propensity to project finance

This dissertation empirically examines a financing and governance structure called Project Finance that typically funds large scale, capital intensive, infrastructure investments in risky countries. Separate incorporation by investing firms (sponsors), long term detailed contracts between suppliers and buyers, vertical integration, high debt levels and non-recourse lending characterizes project finance. Project finance finances tangible, decaying assets with low growth options that do not require strong managerial skills. UK's North Sea oil fields, Ras Laffan gas company in Qatar, and Chad Cameroon pipeline are examples of project financed transactions. Lenders achieve a high degree of transparency for project financed transactions due to the non-recourse nature of the debt which also entails higher setting up costs and cost of debt compared to corporate finance. Theoretical research hypothesizes that project finance solves the problem of potentially opportunistic concentrated suppliers/buyers facing large sunk investments in risky countries. Theory also hypothesizes that project finance mitigates underinvestment resulting from conflict between debt and equity holders within a firm. The dissertation compares project financed and corporate financed transactions in the oil, gas and petrochemical industry to test these hypotheses. I compile a dataset of over 400 investments by 340 firms in 74 countries over 17 years to test these two theories. I find that the propensity of firms to use project finance is high and statistically significant when large sunk investments have concentrated buyers/suppliers in risky countries. The propensity for project finance is high when debt coverage ratios are low after controlling for leverage and the volatility of the debt coverage ratios but weakly so. Project finance therefore fulfills the role of a self regulating contract that reduces transaction costs.