Negotiating Credibly Committed Agreements that Signal Confidence and Continuity Intentions

Technical Notes

Nov 19, 2009 — Neil Boyle

Bilateral trading parties engaged in PPP infrastructure create credible commitments wherein each will have confidence in trading with the other. Prospective investors seek mutual confidence because risk neutral and farsighted suppliers create the conditions for buyers to choose contractual terms that best suit their needs, hence it is in both their interests to seek a mutual alliance. Risk neutral and farsighted PPP suppliers will supply to any contract for which a breakeven result can be projected, and for which differential hazards of breach under various investment and contracting scenarios can be recognized and discounted. (Williamson, 1996).

 PPP parties have a mutual interest in forging a relationship in which both parties are confident. The path to mutual confidence is through the credible commitment of both parties engaged in trading. A credible commitment is not a once and for all secure package as even hostage contracts can unravel when a sovereign state is involved. The reduction of price is not awarded gratuitously; commitments should therefore be carefully thought through so that counterparties are able to see the financial costs and benefits clearly.

Creating credible commitment ex-post. Private ordering can be used to foster credible commitment, especially in the early stages of the relationship. At these stages, focusing on perfectly adjusting the regulatory regime prior to attaining more complete information on the counterparty is foolhardy and costly. Instead, focus on harmonizing credible perceptions of the parties. Because each party acquires its perception about the credibility of the other party through different venues and pathways and times, perceptions at any point are likely to be misaligned. Credible commitment is a process rather than an instantaneous end state and harmonization is needed to bring these pathways into alignment.

A harmonious level of perceived credibility perforce speaks of the existence of private ordering (or at least an important ingredient of it) in the histories of the parties involved—they must share a common experience. The question is how to create these histories expost? The answer is for one party to initiate the giving of credible commitments to the other party by making an offer and waiting for a reply (the absence of a reply is information that was unavailable before the offer).  As mentioned above, price reductions and real responses are not given gratuitously so offers must involve real net benefits to whomever they are being offerred to. Relations between suppliers and buyers mirror the incentive structure involved in giving and taking credible commitments. For simple market exchange, buyers secure better terms from suppliers by giving suppliers relief from demand cancellation penalties. For PPP infrastructure hybrid exchange, governments secure better terms from investors by giving investors relief from the hidden risks of foreign direct investment. Once the parties are reasonably on their way to perceiving each other as credible, recruitment of private solutions is made feasible in that each party possesses a vital part of the knowledge resources that are needed to solve sticky problems and for which private ordering is suited.

Creating credible commitment ex-ante. Creating a credibly committed agreement depends on the quality of negotiations and the competence of negotiators and their knowledge and skill in applying the negotiations triple. Negotiating skill lies with the number and quality of alternative trade-offs that are discussed and acknowledged and accepted by the counterparty. True agreement rather than a zero sum agreement is the object of negotiations. The time and creativity invested in sharing information and explanation will pay dividends in the implementation of a PPP project.

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