Analysing the results of the Private Finance Initiative (PFI)

Category: Accounting

This article considers the results of the Private Finance Initiative (PFI) and public interface in the United Kingdom's public services. Along with briefly reviewing prior research based upon the themes proposed by Broadbent and Laughlin (1999), this article suggests a control system need to create incentive to private firms in recent years.

Introduction

In these day and age, the issue of control and legitimating in government process is debated widely. The Private Financial Initiative scheme which has been given the power over the financial resource whether has been good scheme to reduce cost and share the risk with government.

In the society, people who are working closely with implementing controls tend to have their own self-interest. By looking at the society as whole system that carried with it certain needs from various parts, different role has different interest that must be fulfilled (Émile Durkheim). Organizational functions are to promote integration, stability, consensus and balance.

Key Issue

Who is accountable? To whom?

Is the PFI is the good scheme?

Is that PFI independence? Government control power?

Control lead to control?

Private finance initiative (PFI)

In 1992, UK government seeks private sector to help out the public sector development with large scale and economics knowledge. There are two elements of which private sector have involved: finance and operation. In this essay we focus on the private finance initiative (PFI) which is a method of funding major capital investments that less involving the public fund (cf. Broadbent & Laughlin, 1999; Broad Broad et al., 2000) and that motivate the private sector to be more cost effective in the design, construction and subsequent operation of many public sector projects (McKendrick and McCabe 1997).

The objective and purpose of PFI

The PFI system was created with the purpose to invest in capital without imposing taxes, raising debts or diverting cost from other priorities. It acts as an intermediary between government and private sectors to offer better value for money than public resource by controlling the project over its lifetime. By sharing accountabilities with private sectors, government can reduce the risk and increase benefit to public (Broadbent et al., 2000, p 23).

Achievement of PFI

In term of power, PFI has Institutional power which relies on an external legal or regulatory base from which power derives. They can have the power to force suppliers and contractors to reduce the price and improve performance. They also can create economies of scale by controlling numbers of private contracts.

PFI has proven to be effective in the past for example, during 1992 and 2003, 563 PFI projects with a capital value of £35.5 billion achieve financial close with most of them being decided after 1997 (Her Majesty's Treasury (HMT) 2003). From 1995 to 2002, the annual PFI program has increased from nine projects totaling £667 million to sixty-five projects valued at £7.6 billion (HMT 2003). Estimate by 2010 it is around 200 projects with a total value of £26 billion will be closed (HMT 2006). Without the help of private sectors, government would have paid equivalent amount of fund to provide public service (Gaffney et al. BMJ.1999; 319: 116-119).

Accountability and control of PFI

PFI was given the power of financial resources from government; therefore, they are accountable to government as an agent. In other words, they have responsibility to the work provided (Gray, 1983). Consequently, principal transfers finance as well as the right to define and account what is appropriate to agents.

The PFI deals have been drying up. The number of deals completed in 2009 was almost the worst of 10 years period (FT 2010). The first reason is private sector firms require higher profits for expecting high risk. Therefore, PFI cannot complete the deals with the limited budget that government set. During the financial crisis, the cost of borrowing has been increasing. In fact, private sector interest rates of borrowing are much higher than the government borrowing because there is risk of default. PFI's project has lower profit due to interest repayments is higher than if it had been borrowed by the government. That means they increase the risk oppose to government.

Controlling the source of finance, the agents are accountable for their decision as the one responsibility to perform a certain function. Accountability may be dictated or implied by law, regulation, or agreement or expectation. The agents have to bear the consequences for failure performance as they are accountable for (Hoskin, K. 1996).

Even though, Hoskin (Hoskin, K. 1996) said agents have to take responsibility for their action, in March 2009, the global financial crisis created the difficulty in funding, the Treasury established an Infrastructure Finance Unit in order to ensure the continuation of PFI projects (Timmins, N, 2009). Furthermore, Government has bail out £30m for a second PFI project make up the total of a £700m wasted in May 2009 (Webb, Tim, 2009).

In fact, the deals from PFI are irreplaceable even though they need to be bail out. However, the PFI debt cannot be refinanced without being punished (Worcester News 2009). There will be penalties to PFI for outdate and out budget. Consequently, PFI will take responsible for those losses in front of government for penalties while government has to face the responsibilities to public society.

Control

Principles have been given the power to PFI to control the finance resource as the agents and 'Control is the process by which managers assure that resources are obtained and used effectively and efficiently in the accomplishment of the organization's objectives' (Anthony, 1988). The issue is whether agents prove themselves good scheme or not.

PFI claim to provide control system that can make good use of resource such as:

Legislation penalty act as a motive for firms to complete projects on time and within budget

Private contractors are accountable for maintenance expenses there is motivation for high quality construction.

Private sectors are better managers with better knowledge of market and economies of scale.

PFI can transfers risk from the government to firms. Firms receive profit as the reward for risk taking. PFI has chosen the high risk project

Nevertheless, the agency theory defined; there is the possibility that the agent ignore the wishes of principle. The reason is PFI has their own interest and private information that government has no control. The government has no control over the day by day basic activities of the PFI, so that they can hide the information from government. By secret contract with private firms they can benefit themselves as intermediaries (ICAEW-2009).

Moreover, from interpretive view point, agent has their own culture to gain benefit as for private initiative. Culture is something we share and affect our thinking and behavior. It's also affected the work organization, change the way of interpreting scheme and repeat the same routine make people habit and behavior (Smircich, 1983). Unlike public sector organizations, profit motive is the motivation of private sector. They need to survive, develop and be profitable; therefore, they need to fulfill their need first when they complete the task given by government.

Furthermore, PFI become obsolescence because people get used to the environment and condition. Therefore, they are not aware of the un-certainty risks. Believing their expertise and ignore the risk lead to an urge for the government bailout.

It can be seen that power of government might not change the culture of organization. "The mission to impose a new 'culture' on public sector organizations via structural solutions based on market theory often fails to analyze the old culture or the underlying value structures and administrative politics" (Gray & Jenkins, 1995).

Control systems must be sensitive to organizational culture. Those running counter to culture are unlikely to be successful (Hofstede, 1981). Therefore, the government has allowed the PFI to operate as they have been.

On the other hand, one of the key arguments is that government can control the agency through societies and organizations pressure. For example, government can introduce legislation over term and condition of contracts or condition of economy such as interest rate, tariff and so on. (Broadbent 2003)

As an agent PFI work under the government wants but not as they suppose to, therefore, their system become obsolescence and incapable to adapt. A project delivery model which focuses less on innovative outcome and produces facilities might not be able to deal with future changes in demand (James Barlow, Martina Köberle Gaiser 2008). The money from public has been wasted. Taking NHS as an example they have wasted £350m a year on outside management consultants at their own expenses, while taxpayer pay billions to companies who gain benefit in the NHS from PFI. (Guardian Feb 2010).

In my opinion, PFI is good scheme for public interest as they have been providing help and funding major capital investments, without relying on immediate aid from public sources. However as agency theory defined, their work is not efficient as they proclaim because of obsolescence, their own interest and other forces (Baiman1982).

Government

Government accountabilities & control

Government has been given power by society through voting so they are accountable to public interest. In the power theory (radical paradigm), government have gain enormous power to control over the society. They have the ability to influence behaviour, change the track of events, triumph over resistance, and get people to do things that they would not do (Pfeffer, 1992).

As a principle of PFI, they have the power to control PFI, their performance and process. For example, in 2009, the government changes the accounting standard (FT, 2010) to adapt with international accounting. Government politically, forms the way to collect more detail of how PFI is processing, and should process in practice. The government also steer the society using regulations and social systems. (Broadbent & Laughlin, 1997)

Although, as indicated above, PFI might hide some information from principle, government has other way to control their detail provided with National Audit Office (NAO). By providing the auditing over PFI project, they can reduce the neglects of agency with private information. Consequently, government can control PFI public results as they please and force PFI to follow government wishes.

However, the government has control over PFI while the bailout has been increasing rapidly. The reason is because their system has less effective. Mark Mattison discussed that PFI has been provided its best value agenda in term of time, cost of capital and related results (Mark Mattison 2009).

The possible reason is NAO is also an agent so that the government might not be able to get hold of PFI public report. An agency theory "suggests that principals have lack reasons to trust their agents. The owner will find to resolve these concerns by putting nontrivial monitoring costs to align the interests of agents with principals and to reduce the scope for information asymmetries and opportunistic behavior" (ICAEW-2009). The government can trust in NAO and PFI report or they need to have another company to look over.

Additionally, government has less knowledge of expertise than private firms. They tend to focus more on the work and politic rather than economic. Therefore, the plan has failed to force PFI to take the extreme risk with low return.

Moreover, private firm need to be motivated in order to perform better. By motivate agents, principle can receive better results. Taking one factory, Hitachi used direct labour hours as overhead allocation base to create incentive for automation; they reduce their cost and increase their output (Hiromoto, 1991).

From public point of view, the control over government was low because public only can vote once over 4 years for the party to take control. They gain control over the countries so that public has no control over day by day basic of government.

The problem of managerial and political accountability

Government with the power of political as a result of their power base in global capital markets which was achieved through their role in the allocation of surplus value (Armstrong, 1987). They provide public with context of control over PFI. Stewart (1984) suggests that managerial and political accountability as different levels.

A key argument is that governments only accountable in a political, rather than managerial term. Consequently, government makes an increasing in ways of control over society. Because of their unique power in society, which their existence is depending on how they exercise control over society, anything they do has a controlling outcome. In combination with a lack of day by day control by the election, which has power to vote these bodies but without a power to dictate practical action, leaves governments in a uniquely powerful position. (Jane Broadbent and Richard Laughlin 2003)

Moreover, government culture is politic. They cannot simply change their behaviour to managerial just to control the system of PFI (Hofstede, 1980 -1983). The culture of public sector was showed as "the mission to impose a new 'culture' on public sector organizations via structural solutions based on market theory often fails to analyse the old culture or the underlying value structures and administrative politics" (Gray & Jenkins, 1995).

Conclusion

In my opinion, with the power to control PFI through many forms in the society, government makes them less incentive and interdependence on government and associate. Government is under low control of society, so they do not take the responsibility as a managerial but political.

Discussion of the control system

In the end, the remaining question is "Do control lead to control". As far as I am concern, the answer can be no.

Firstly, agency problem is a matter of conflicts between self interests, thus, agency theory seeks to balance the differences to determine the optimal contract for an agent's service (Eppen, 1987). However, the question is can people trust the control of control (Baiman 1982). Because as NAO is an audit they still an agent of government, they might provide inaccurate report to government. Moreover, the public point of view is NAO is also under the control of government so that the report they provide cannot be trusted.

Secondly, the reason is stress make people less motivate. As the essay indicated earlier PFI tend to work less efficiently. They follow the government order instead of doing what they should do. That makes the system become obsolescence. Another alternative paradigm for management control & accountability is that people are dominated by the ideological superstructures with which they interact. The culture of organization depends on the emergence of shared interpretive schemes, expressed in language and other symbolic constructions that develop through social interaction. Such schemes provide the basis for shared systems of meaning that allow day to day activities to become essential routines or culture (Smircich, 1983). Consequently, the change in control can lead to a depression.

On the other hand, the public organizations such as HMT, NAO and the Office of Government Commerce (OGC) have made recommendations to improve the operation of the scheme. They bring the control to PFI force them to work with the penalties as an incentive to perform in time and budget. (J Laffont and D Martimort 2002)

Contingency theory implies that different systems should be adopted in response to different environmental conditions and claims that there is no one best way to make a decision (Otley, D. 1980) hence, any decision that has been made regardless of its suitability at the time, will still be subject to the environmental and external impacts, therefore appropriate contingent plans needs to be established to take into account the risks that are likely to arise in order to best encounter the uncertainties lies beyond. As each method has its limitation we should be aware, Variable factors will affect the business in different ways. Thus, there is no best way to manage organization when making a decision.

Conclusion

In conclusion, the control process needs to be analyzed better before the government introduces new control process. It depends on the situation and culture of firms they control. Looking at different literature, I can conclude that Government are heavily involved in political tasks, but are gradually involved in management and providing private initiative better influence and make informed decisions on strategic plans, as opposed to just being tools in the process. Therefore, both their interests align and they can work together towards the same goal. This however does not work if a gap is apparent between the two. Accountants will not take much notice of controls if they are not involved in making informed decisions and dealing with management. In my opinions, in current economy the private initiative need to get motivate rather than control.