Termination Fees and Contract Design in Public-Private Partnerships
D81, D82, D86, H54
Public Projects, Public-private Partnerships, Adverse Selection, Real Options, Investment Timing, Termination Fees
Economic Theory and Applications
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.
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.