Evaluation of the excess revenue sharing ratio in PPP projects using principal–agent models

Abstract

In PPP projects, a reasonable risk-sharing system determines whether project financing will be successful. It is often necessary for the host government to provide investors with certain guarantees that relieve some of the risk shouldered by the private parties in order to attract investment. For instance, a minimum revenue guarantee (MRG) supplied by the government reduces the market risk taken by the investor. Based on the principle that the benefits one receives should be fairly equal to the risks taken, governments have the right to share any excess revenue the investors gain equal to the difference between the actual revenue gained by the investors and the cap of the expected earnings. As a result, an excess revenue sharing ratio has to be determined. This paper integrates the fairness preference theory with the traditional principal–agent model in order to calculate optimal incentives when principals (governments) employ agents (investors) who have fairness preferences. This study shows that sharing ratio of the excess revenue is related to the fairness preferences and the effort cost coefficient of the investors. Furthermore, governments can obtain more expected revenue when hiring investors with higher fairness preferences.