Holdup and Firms’ Relative Advantage in Private Infrastructure Projects

Abstract

Private sector investment in large infrastructure projects calls for firms to invest in specific assets with a high degree of government control. Under such conditions, governments can act opportunistically to appropriate returns from firms’ investments. Contrary to this view, we highlight how opportunistic firms may gain favorable outcomes at the expense of the state. Drawing on transaction cost economics and temporal specificity, we argue that firms may hold up incumbent elected officials by threatening to delay or disrupt provision of infrastructure services. Seeking to avoid the perception of administrative incompetence and any resulting adverse political consequences, elected officials acquiesce to firms’ demands in contract renegotiations and provide additional rents at the expense of the state. We expect the likelihood of firm-led holdup to increase with political competition, proximity of elections, and wide salience of the infrastructure service. Firms with weaker reputations and low-trust relationships with the state are more likely to engage in such behavior. We discuss the implications of our arguments for policy and managerial practice.