Analysis of the risk-sharing ratio in PPP projects based on government minimum revenue guarantees

Abstract

Public-private partnership (PPP) projects have been widely applied in infrastructure construction. A suitable risk distribution strategy is crucial for promoting negotiations between the government and investors. The government usually provides guarantees to investors to distribute risk. However, an excessive guarantee increases the government's financial burden, whereas an insufficient guarantee reduces the confidence of the investors participating in the project. In a minimum revenue guarantee (MRG), the government subsidizes the investors the difference between the actual revenue and the government guarantee line if there is a loss. In PPP power plant and highway projects, investors' revenues come from two sources: government guarantees and the project company's self-sale. To support project companies and to optimize the projects' benefits, the government should set a reasonable benchmark for purchase amounts. Based on the traditional principal-agent model, this paper introduces the reciprocal preference theory to analyze the risk-sharing ratio most suitable for the government. Then, an optimal incentive mechanism is established to guarantee the project's income. The results indicate that by setting a different guarantee strategy for different participants, the government can utilize reciprocal preference to incentivize investors to exert more effort during a partnership and avoid moral hazard.