Incentives of Early Termination Compensation in Public–Private Partnership Projects

Abstract

Public–private partnership (PPP) projects often end in early termination and the governments must compensate private-sector partners and take over project assets. Based on multicountry experience, this article proposes a systematic approach on when and how to compensate efficiently and fairly. A compensation model was first developed to quantify the amount paid to the private-sector partners when early termination occurs, and built upon that, an incentive model was proposed to analyze the incentives of both contracting parties. We then testified our propositions through two realistic cases. In line with the incomplete contract theory and the reference point theory, the findings demonstrate that the proposed compensation method increases the the private sector's incentives of relationship-specific investments, but discourages its efforts to prevent early termination in serious risk scenarios. This article not only contributes to the theoretical development of PPPs on contract design and incentive mechanisms, but also offers solutions for practitioners in the early termination of PPP projects.