Signaling contracts design for Build–Operate–Transfer roads under asymmetric traffic demand information

In a build-operate-transfer (BOT) road project, the government offers a concession contract to a private investor based on traffic demand information. When the government is privately informed about the demand information—namely, the potential traffic demand (PTD)—it might be challenging for the private investor to quantify the project’s prospects, which could diminish its enthusiasm for involvement. In that case, the government has incentive to design a concession contract that acts as a signal of facility demand to the private investor. This study uses a signaling model to develop an incentive-compatible BOT contract when the government possesses an informational advantage concerning PTD. We find that the optimal contract for the government under the high-PTD condition is distorted relative to a symmetric-information contract. However, this distortion comes at the cost of social welfare loss, which can be viewed as signaling cost, and it is affected by PTD variation and the marginal social cost of public funds. In a separating equilibrium, optimal contracts lie in one of four regions whose bounds are determined by PTD variation. We further extend the research by considering the private investor’s risk-averse attitude. We find that the existence of an optimal signaling mechanism is influenced by the extent of risk aversion (ERA). Interestingly, however, a risk-averse attitude does not magnify the distortion of an asymmetric-information contract, and the signaling cost decreases with ERA. The ranges of separating equilibrium outcomes are also influenced by ERA. Based on our findings, we derive some policy insights regarding BOT contracts design.