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A barrier real option approach to evaluate public–private partnership projects and prevent moral hazard

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  • Antonio Di Bari

    (University of Bari)

Abstract

When governments contend with financial restrictions, they may form public–private partnerships (PPPs) to help fund projects. In these types of investments, private firms (i.e. concessionaires) develop public projects. The government supports the funding of these public projects by sharing the risk of future potential losses. To implement the risk-sharing mechanism, public administration could adopt a Minimum Revenues Guarantee (MRG) option for the concessionaire in the agreement. On the other hand, the government should monitor possible opportunistic morally hazardous behavior by private firms derived by fraudulent exercise of this option. This paper aims to evaluate a MRG option while considering both moral hazard and an adjusted version of the Real Option Approach (ROA). A threshold (i.e. barrier) to the project profitability evolution is applied, below which the concessionaire would lose their right to exercise the option. Identifying these factors should encourage private firms to pursue the best possible management performance and avoid moral hazard. This paper also proposes a numerical example to validate that private firms would have no advantage in conducting opportunistic behavior because such behavior would reduce the project value.

Suggested Citation

  • Antonio Di Bari, 2021. "A barrier real option approach to evaluate public–private partnership projects and prevent moral hazard," SN Business & Economics, Springer, vol. 1(3), pages 1-19, March.
    • Handle: RePEc:spr:snbeco:v:1:y:2021:i:3:d:10.1007_s43546-021-00042-z
    DOI: 10.1007/s43546-021-00042-z
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    References listed on IDEAS

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    1. Marzouk, Mohamed & Ali, Mohamed, 2018. "Mitigating risks in wastewater treatment plant PPPs using minimum revenue guarantee and real options," Utilities Policy, Elsevier, vol. 53(C), pages 121-133.
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    4. Lenos Trigeorgis, 1993. "Real Options and Interactions With Financial Flexibility," Financial Management, Financial Management Association, vol. 22(3), Fall.
    5. Nunzia Carbonara & Nicola Costantino & Roberta Pellegrino, 2014. "Revenue guarantee in public-private partnerships: a fair risk allocation model," Construction Management and Economics, Taylor & Francis Journals, vol. 32(4), pages 403-415, April.
    6. K.C. Iyer & Mohammed Sagheer, 2011. "A real options based traffic risk mitigation model for build-operate-transfer highway projects in India," Construction Management and Economics, Taylor & Francis Journals, vol. 29(8), pages 771-779, June.
    7. Cox, John C. & Ross, Stephen A. & Rubinstein, Mark, 1979. "Option pricing: A simplified approach," Journal of Financial Economics, Elsevier, vol. 7(3), pages 229-263, September.
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    Cited by:

    1. Michele Bufalo & Antonio Di Bari & Giovanni Villani, 2023. "A Compound Up-and-In Call like Option for Wind Projects Pricing," Risks, MDPI, vol. 11(5), pages 1-13, May.

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