Abstract
AbstractWe study the effects of granting an exit option allowing the private party to terminate a Public–Private Partnerships contract early if it turns out to be loss‐making. In a continuous‐time setting with hidden information about the private returns on investment, we show that an exit option, acting as a risk‐sharing device, can soften agency problems and, in so doing, spur investment and increase the government's expected payoff, even while taking into account the costs that the public sector will have to meet in the future to resume the project.
Highlights
Partnerships between private and government entities for the provision of public services are not exclusively a contemporary phenomenon
The term public–private partnership (PPP) covers a wide range of contractual arrangements, that share some common features that differentiate them from other forms of cooperation between the public and the private sector
Compared with conventional procurement methods, a distinctive feature of PPPs is that the private party must take a substantial proportion of risk, insofar as they generally involve responsibility over several project functions and remuneration is closely tied to performance (World Bank, 2017)
Summary
Partnerships between private and government entities for the provision of public services are not exclusively a contemporary phenomenon. Our main result is that an exit option can limit the differentiating value of delay and rents left to the private party, inducing more efficient investment thresholds at a lower public cost.
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