Impact of government subsidy on BOT contract design: Price, demand, and concession period

Abstract

Private provision of logistics infrastructure through build-operate-transfer (BOT) contracts has become increasingly popular worldwide. These contracts involve incentive conflicts between private sector concerning profit and government concerning social welfare. To coordinate the incentive conflicts, the government usually subsidizes the private sector in practice. In this paper, we propose a stylized model to illustrate how to design an optimal BOT contract with government subsidy. We first derive optimal subsidy levels for the government to obtain optimal social welfare, given concession periods. We further observe that there exist both a substitution effect and a complementary effect between the concession period and the subsidy level. For the former (latter), the subsidy is decreasing (increasing) in the concession period, and the substitution effect can be strengthened if the government has subsidy budget constraint. Interestingly, we find that the private sector does not always prefer the longest concession period. A concession period less than the lifetime of the infrastructure may be more beneficial for the private sector. In contrast, the government's preferred concession period can be either zero or the longest concession period, depending on the unit construction cost and the government's inefficiency cost. We further find that, the incentives of the government and the private sector over the concession period can be aligned when the unit construction cost is low and the government's inefficiency cost is high. We also find that their incentives over the infrastructure's capacity utilization are always aligned throughout the BOT periods.