Optimal choice of capacity, toll, and subsidy for build-operate-transfer roads with a paid minimum traffic guarantee

Government sectors often provide guarantees in build-operate-transfer (BOT) roads to attract private investments. Since a fiscal burden would be incurred from the contingent liability of issuing a guarantee, charging a fee for the guarantee is considered an effective remedy for management of contingent liabilities in practice. This study incorporates the charge mechanism for minimum traffic guarantee (MTG) into consideration, and proposes a method to choose the optimal concession contract variables with a paid MTG. We find that the government sector will specify a lower toll and a higher capacity for a BOT road with a paid MTG. As a result, the society suffers a social welfare loss when providing a paid MTG. Meanwhile, both the charging fee of an MTG and the guaranteed traffic volume would increase the loss of social welfare, which means the incentive mechanism of private participation and the management of contingent liabilities (charging fee for MTG) are all at the expense of social welfare. Moreover, since the welfare loss is magnified under a high marginal social cost condition, the government should set the charging fee and guaranteed traffic volume according to the marginal social cost level. In addition, to obtain more insights, this paper has made two extensions to further investigate the effects of a paid MTG (1) when contracting with a risk averse private investor; (2) when the concession period is an endogenous variable. Based on our model results, this paper derives several policy implications regarding BOT contract design when a paid MTG is provided.