Abstract
Public-private partnership (PPP) is becoming increasingly popular around the world for the development of infrastructure. However, it is vital that the private sector knows how to make its investment decisions, especially when it bears the burden of completion risk, and the cash flow of PPP projects is hard to predict. In previous studies, completion risk and project profitability have been recognized as critical factors that influence the involvement of the private sector in PPP projects. This study further investigates how these two factors affect private sector investment decisions, including its involvement, withdrawal, and capital structure decisions. First, a continuous real option method is built to explore the investment boundary and default boundary of the private sector. The results show that an increase in completion risk does not necessarily increase the investment boundary; rather, the relationship between them depends on the degree of private sector risk tolerance. The results also indicate that the investment boundary decreases with the expected rate of return and increases with the tax rate, risk-free rate, and volatility of cash flow. The default boundary decreases with the expected rate of return and volatility of cash flow and increases with the risk-free rate. Second, by comparing two different financial arrangements, the results suggest that using debt capital can help lower the private sector’s investment boundary. Third, the results reveal the optimal debt level of private sector investment in PPP projects by showing that the optimal debt level increases with the tax rate and decreases with the default loss rate. These results can provide some managerial insights for the private sector as it makes decisions on PPP project investments. They can also provide some policy insights for governments to better promote private sector investment in PPP projects.
Highlights
With the financial burden of governments growing around the world, the public-private partnership (PPP) model is becoming increasingly popular in infrastructure development [1,2]
In PPP projects, the private sectors are mainly responsible for financing, building, and operation of projects [3,4]. is approach can largely decrease the financial burden on the government while gaining more advanced managerial and technical experience from the private sectors in infrastructure development [5]
Since the cash flow of PPP projects is hard to predict and the private sector must shoulder the burden of the completion risk, it is vital for the private sector to know how to make its investment decisions according to different completion risk and project profitability situations. Set against this contextual backdrop, this paper aims to investigate how completion risk and project profitability affect the investment decisions of the private sector in PPP projects
Summary
With the financial burden of governments growing around the world, the public-private partnership (PPP) model is becoming increasingly popular in infrastructure development [1,2]. In PPP projects, the private sectors are mainly responsible for financing, building, and operation of projects [3,4]. Is approach can largely decrease the financial burden on the government while gaining more advanced managerial and technical experience from the private sectors in infrastructure development [5]. To make use of the advantages of the PPP model, since 2014, the Chinese government has drafted several policy papers to encourage private sectors to invest in infrastructure development. Private sectors have demonstrated their interest in PPP projects, they have hesitated to invest in them. To better direct the private investor involvement in PPP projects, it is imperative to investigate how different factors affect the investment decision of the private investor
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