Investment Incentives in Project Finance in the Presence of Partial Loan Guarantees

Abstract

In this paper, we study the role of government financial guarantees as catalyst for project finance (PF). On the one hand, the government's incentive compatibility and participation constraint determine the optimal portion of the loan to be backed. On the other, the borrowing interest rate satisfies the debtholders’ participation constraint. The project's sponsor may choose to underinvest or overinvest depending on its own capital contribution, the risk technology, the risk measurement errors, and the proportion of guarantee provided by the government. We derive the project optimal investment level as well as the government partial loan guarantee coverage. We also discuss the impact of the risk measurement errors on the project's credit spreads.

Citation

Son Lai, V. and Soumaré, I. (2005), "Investment Incentives in Project Finance in the Presence of Partial Loan Guarantees", Chen, A.H. (Ed.) Research in Finance (Research in Finance, Vol. 22), Emerald Group Publishing Limited, Leeds, pp. 161-186. https://doi.org/10.1016/S0196-3821(05)22006-3