FEEM working papers "Note di lavoro" series
2018 .032

Termination Fees and Contract Design in Public-Private Partnerships


Authors: Marco Buso, Cesare Dosi, Michele Moretto
Series: Economic Theory
Editor: Matteo Manera
Keywords: Public Projects, Public-private Partnerships, Adverse Selection, Real Options, Investment Timing, Termination Fees
JEL n.: D81, D82, D86, H54

Abstract

We study the effects of granting an exit option that enables the private party to early terminate a PPP project if it turns out to be loss-making. In a continuous time setting with hidden information about stochastic operating profits, we show that a revenue-maximizing government can optimally trade-off direct subsidies for capital investment against the right of opting out the PPP. In particular, the exit option, acting as a risk-sharing device, can soften agency problems and increase the value-for-money of public spending, even while taking into account the budgetary resources needed to resume the project in the event of early termination by the contractor.

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Suggested citation: Buso, M., C. Dosi, M. Moretto (2018), 'Termination Fees and Contract Design in Public-Private Partnerships', Nota di Lavoro 32.2018, Milano, Italy: Fondazione Eni Enrico Mattei.

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