The effect of investment size and risk of creeping expropriation toward propensity to project finance in infrastructure sector in Indonesia

This paper empirically examines an off balance sheet financing mechanism called project finance. This mechanism involves creation of a legally independent project firm financed with equity from sponsors and is characterized by limited or no recourse lending, long-term contractual agreements, and vertical integration. Paiton Energy, Ras Laffan LNG, and London Underground are few examples of project finance use. Theoretical framework suggests that project finance mechanism can mitigate transaction cost in large investment and risk of creeping expropriation that might entail. This paper uses a dataset of 43 corporate finance and project finance investments in mining, oil and gas, power, water utility, waste treatment, transportation, and storage sector in Indonesia within 2007-2012 period. The result suggests that the propensity to use project finance is high and statistically significant when there is concentrated supplier/buyer and presence of State-owned Enterprises as concentrated supplier/buyer in the project. The effect is amplified when sponsoring firm has low debt service coverage ratio.