2.3.4 Corporate Structure

The fourth TICCS® pillar classifies the corporate structure of infrastructure companies into two classes and two subclasses. The behaviour of a firm and its managers differs depending on if whether it was created to develop a single project or multiple ones. A firm's level of external debt financing also impacts its behaviour. External debt financing creates a demand for monitoring on the part of creditors, especially with single-project firms. External monitoring alters the behaviour you would expect to see in a firm and its managers.

Academic Insights

Infrastructure companies typically take one of two corporate forms: 'projects' or 'corporates.' Infrastructure project companies are single-project firms or project-financed. Infrastructure corporates are multi-project companies more akin to corporate-governance structures found in other industrial sectors. These two types of firms can be expected to exhibit fundamentally different behaviours.

Infrastructure project companies are created in the context of a long-term contract between an investor (the owner of the project company) and a public- or private-sector client. Project companies are created for the sole purpose of delivering a new tangible infrastructure asset and operating it for the length of the contractual period. Infrastructure project companies are also referred to as special-purpose vehicles (SPVs) or special-purpose entities (SPEs). They typically serve as the focal point of a nexus of contracts between investors, builders, operators, a client, and providers of long-term finance, usually in the form of long-term senior debt. The formal definition of project financing put forward in the Basel-II Accord is reproduced in the appendix.

Debt plays a significant role in project finance because it tends to be the main source of capital. The theoretical literature on project finance and corporate governance (for example, see Shah, 1987) highlights the role of leverage as one of the most counter-intuitive dimensions of project financing. Project financing reduces the net financing costs associated with large capital projects (Esty, 2004) because external debt plays an important disciplinary role by preventing managers from wasting or misallocating free cash flows and deterring related parties, including the public sector, from trying to appropriate them (Hart, 1995; Jensen, 1976).

Because leverage mitigates these costly incentive conflicts among capital providers, managers, and investors, it increases expected cash flows available to capital providers, thereby establishing a link between financing structure and asset values. In this context, the presence of significant loan financing is a signal of creditworthiness (Fama & French, 1997).

Indeed, infrastructure assets have few growth options, which hinders over investing in negative-NPV projects and makes investment decisions more easily monitored by external claim holders. When raising financing, infrastructure project companies typically commit to a given capital program and are not able to seek other sources of financing without the explicit involvement of their original creditors. In the event of various credit events, senior creditors have control rights akin to those of majority shareholders and can require a financial restructuring or even take over the company from its original owners.

The empirical literature on infrastructure project finance (Blanc-Brude, 2007; 2018; Brealey, 1996; Esty, 2002) shows that project financing typically relies on high levels of non-recourse external debt financing (typically between 60 and 90%) and concludes repeatedly that project finance loans have different characteristics from corporate debt. In corporate finance, debt can be used to increase returns on equity, creating incentives to take risks. In project finance, because the financial viability of a single project has to be demonstrable ex-ante with a high probability, debt is used to minimise the cost of capital and creates incentives to minimise risk.

By contrast, infrastructure 'corporates' or multi-project companies have all the usual characteristics of the firm: managers have more freedom to make various investment decisions and can change course both strategically and financially over time. They can take on new projects, including those in sectors that are not directly related to infrastructure (e.g., utilities investing in media companies) or invest internationally in other infrastructure firms (e.g., European utilities invested in Asian utilities in the mid-1990s), thereby changing their business-risk profile.

Likewise, infrastructure corporates are free to change their financial structures and can use multiple sources of private and public financing. Creditors play a much more limited monitoring role and do not have different control rights in the event of default than with other corporate borrowers. Nor do they play a leading role in the financial structuring of the firm either before or after credit events.

As a result, high or increasing levels of indebtedness in infrastructure corporates are typically interpreted as signalling higher credit and equity risk. UK water utilities are a case in point (Helm, 2009).

The TICCS® Corporate Structure Classification

Single-project infrastructure companies can be found in any of the industrial classifications identified in the TICCS® second pillar, in particular social infrastructure, road, and conventional or renewable power generation projects. Infrastructure corporates or multi-project companies tend to be found in the utilities sector and in some transportation sectors (ports and airports), where they have often existed for several decades. Regulated infrastructure companies defined in the first TICCS® pillar also tend to be infrastructure corporates. In principle however, the TICCS® corporate-governance classifications are not exclusive of any of the other classes defined in the other three pillars.

As noted above, external debt financing creates monitoring mechanisms that can be expected to have a significant impact on the behaviour of managers and the predictability of the firm's activities and risk profile.

As asset owners and managers become the new owners of infrastructure project companies, they sometimes reimburse senior creditors early (prepayment) and replace external senior debt instruments with shareholder-provided debt or refinance project debt at the portfolio or group level (e.g. HoldCo).

Such decisions can lower the cost of external financing, but they also remove the project-level monitoring function of external creditors that is so characteristic of single-project infrastructure companies and has contributed to its historic performance track record.

Using these insights, the TICCS® fourth pillar includes two classes of corporate governance and four subclasses. We differentiate between subclasses of 'monitored' and 'unmonitored' project companies as shown.

• CS1: Infrastructure projects

  • CS10: Monitored infrastructure project companies with substantial external senior debt

  • CS11: Unmonitored infrastructure project companies without substantial external debt

• CS2: Infrastructure corporates

The table below describes the TICCS® corporate-structure classification.

_{Blanc-Brude, F. and Strange, R. (2007). How Banks Price Loans to Public-Private Partnerships: Evidence from the European Markets. Journal of Applied Corporate Finance, 19(4), 94–106.}

_{Blanc-Brude, F., Hasan, M., & Whittaker, T. (2018). Calibrating credit risk dynamics in private infrastructure debt. Journal of Fixed Income, 27(4).}

_{Brealey, R.A., Cooper, I.A., & Habib, M.A. (1996). Using Project Finance to Fund Infrastructure Investments. Journal of Applied Corporate Finance, 9(3), 25–39.}

_{Esty, B.C. (2002). Returns on Project Financed Investment. Journal of Applied Corporate Finance, 15(1), 71–86.}

_{Esty, B.C. (2004). Why Study Large Projects? An Introduction to Research on Project Finance. European Financial Management, 10(2), 213–224.}

_{Fama, E.F. & French, K.R. (1997). Industry costs of equity. Journal of Financial Economics, 43, 153–193.}

_{Hart, O.D. (1995). Firms, Contracts, and Financial Structure. Clarendon Press.}

_{Helm, D. (2009). Infrastructure Investment, the Cost of Capital, and Regulation: An Assessment. Oxford Review of Economic Policy, 25(3), 307–326.}

_{Jensen, M.C. & Meckling, W.H. (1976). Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure. Journal of Financial Economics, 3(4), 305–360.}

_{Shah, S. & Thakor, A. (1987). Optimal Capital Structure. Journal of Economic Theory, 42, 209–243.}

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