How much construction risk do sponsors take in project finance?

by Frédéric Blanc-Brude, Dejan Makovsek
Abstract:
Using new data, we show that construction risk in infrastructure project finance is well- managed and that project sponsors face very little construction risk compared to the well-documented, systematic and very large costs overruns found in traditional infrastructure project procurement. We know from the project management literature that construction risk is significant in public infrastructure projects delivered through traditional procurement methods. We also know that, when similar projects are procured using project financing, construction risk is passed on through date-certain, fixed price contracts. However, there is, to our knowledge, no available empirical research on the significance of construction risk once it has been passed on. Using a dataset of ex ante and ex post construction costs in infrastructure project finance, we find, with a high degree of statistical significance that construction risk in infrastructure project finance is well managed and that expected cost overruns should be zero, while project specific risk is completely idiosyncratic and therefore diversifiable from the point of view of the SPE i.e. investors in infrastructure projects. We also find, with a high degree of statistical significance that the construction risk to which the private sponsor is exposed in infrastructure project finance is different from that to which the public sector sponsor is exposed in traditional infrastructure procurement.
Reference:
How much construction risk do sponsors take in project finance? (Frédéric Blanc-Brude, Dejan Makovsek), In EDHEC-Risk Institute Publications, 2014.