Risk Shifting Through Nonfinancial Contracts: Effects on Loan Spreads and Capital Structure of Project Finance Deals

Infrastructure Projects are large investment by the public and/or private sector that required enormous financial resource commitment to build physical asset and facilities needed for economic development so that the company need project financing to support with. Project finance is based on debt repayment from project companies’ revenue and not on the sponsors or the developer’s balance sheet, so the project companies should assure the cash flow is sufficient for debt repayment and dividend payment. Beside that investors still have to analyze the value created in that project with highest positive Economic Value Added. Net Operating Profit After Tax (NOPAT) need to cover cost of invested capital to create value so that the ratio of NOPAT to total Project Cost (Return on Invested Capital) is should be more than the weighted average cost of capital (WACC). The capital structure doesn’t have an optimum weight and cost as long as the Return on Invested Capital (ROIC) higher than WACC.

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Limited-and Nonrecourse Project Finance: a Survey

Estudios de Administración ◽

10.5354/0719-0816.1995.56694 ◽

2020 ◽

Vol 2 (1) ◽

pp. 27

Author(s):

Stefanie Kleimeier

Keyword(s):

Capital Structure ◽

Cash Flows ◽

Legal Framework ◽

Project Finance ◽

Transfer Model ◽

Academic Literature ◽

Comprehensive Literature Review ◽

Project Risks ◽

Project Participants ◽

Project Company

This paper reviews limited- and non-recourse project finance, a special financing approach for newly to be developed projects where the funds are directly linked to the cash flows of the project. This survey comprises a comprehensive literature review on project finance. Practitioner literature is reviewed with respect to project risks and hedging possibilities, project participants, the legal framework of the project company, the financial elements, and a special form of project finance: the build-operale-transfer model. Next to practitioner oriented literature, the academic literature is reviewed which models project finance as an element of a capital structure equilibrium. An appendix lists references of practitioner's articles on project finance and thus allows the reader to gather information about specific areas in project finance, for example with respect to requirements for project finance in various industries or countries.

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Designing Bankers’ Pay: Using Contingent Capital to Reduce Risk-Shifting Incentives

Quarterly Journal of Finance ◽

10.1142/s2010139222400055 ◽

2021 ◽

pp. 2240005

Author(s):

Jens Hilscher ◽

Sharon Peleg Lazar ◽

Alon Raviv

Keyword(s):

Capital Structure ◽

Convertible Bonds ◽

Risk Shifting ◽

Asset Risk ◽

Contingent Capital ◽

Risk Equity ◽

Increase Risk ◽

Reduce Risk ◽

The Capital Structure

Including contingent convertible bonds (coco) in the capital structure of a bank affects the sensitivity to risk of its equity-based compensation. Such risk-shifting incentives can be reduced if the coco bonds are well-designed. Similarly, we show that compensating executives with well-designed coco bonds can also reduce risk-shifting incentives. In practice, however, most coco bonds have characteristics that result in both stock and coco compensation having large sensitivities to changes in asset risk — equity-based compensation encourages executives to increase risk, coco compensation to reduce risk. We show that a pay package combining both stock and coco can practically eliminate risk-shifting incentives and that it can be implemented with a bank’s preexisting coco bonds.

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