Determination of government guarantee and revenue cap in public–private partnership contracts

Abstract

PurposeConsidering there is a lack of research in determining the optimal levels of government guarantee and revenue cap, the objective of this research is to determine their optimal levels to achieve a reasonable financial risk allocation between governments and private investors while avoiding overly lucrative conditions for private investors.Design/methodology/approachExpanded net present value (NPV) analysis and bargaining game theory are employed to construct the core of the determination process. The risk gap between governments and private investors is assessed via an expanded NPV analysis to see if the financial risk has been shared reasonably, based on which the range of the government guarantee is decided. A bargaining model is then created to help locate the optimal level of the government guarantee. Finally, a revenue cap, often combined with the government guarantee in public–private partnership (PPP) agreements, will be determined if overly lucrative conditions for private investors are observed or governments suffer a risk spillover.FindingsReferring to a real PPP project in Australia, Project BA is created to validate the applicability of the proposed determination process. The outcome shows that the proposed determination process in this paper is capable of determining the optimal levels of government guarantee and revenue cap. The government preferences towards risk allocation will influence the values of the optimal levels. Governments may also consider to alleviate the control over investors' net profits to mobilise private investors into PPP projects.Research limitations/implicationsThere is a potential possibility that the revenue cap fails to control the financial risk for governments or the overly lucrative condition for private investors. In other words, even though the revenue cap is set at the minimal level, the financial risk for governments still beyond their tolerance range or the overly lucrative condition for private investors still occurs. Future research may focus on other financial protective schemes which help to better control the financial risks for governments and profits for private investors.Originality/valueGovernment guarantees are frequently used as an investment incentive to reduce the probabilities of suffering loss for private investors. Nevertheless, the financial risks for governments may increase after providing guarantees and, as a result, revenue cap is required by governments to avoid placing themselves in an unprotected situation. By recognising the importance of the two contractual parameters, many scholars dig into their option values. However, there are very rare research works focussing on the method of determining the specific levels of government guarantee and revenue cap. To overcome the limitations of existing models and enrich the methodology for government guarantee and revenue cap determination, this paper contributes to the body of knowledge by developing a government guarantee and revenue cap determination process which contributes to a reasonable allocation of financial risks between governments and private investors.

PPP project price mode typologies: a China-based comparative case study

“…However, when we summarize the combination structure of concessionary items as a price mode, the concession period cannot be utilized to differentiate those modes. More recently, multiple concessionary items and their interrelationships have been considered (Jin et al ., 2021, 2023; Bayat et al ., 2020; Yuan et al ., 2019; Zhang et al ., 2021, 2022). Despite a recognition of the vital role of a cluster of concessionary items, these have also not been evaluated in terms of relative impact.…”

Public–Private Partnership (PPP) in Road Infrastructure Projects: A Review of Evolution, Approaches, and Prospects

“…Effective implementation of government guarantees will contribute to building investor confidence, thus facilitating the successful financing and implementation of PPP projects. However, methodologies for identifying maximum and minimum levels of government guarantees should be further developed [82]. The bidding, awarding, and control phases of PPP contracts for highway projects are crucial to the project's success.…”

Project-focussed literature on public-private partnership (PPP) in developing countries: a critical review

“…Here, Residual value risk (RVR) is defined as "…the risk that on expiry or earlier termination of the service contract, the asset (tangible or intangible) is not in accordance with the value originally estimated by the government at which point the private party agreed to transfer it to the government" (p. 04014041). Examples of other PPPrelated literatures are those focused on tendering (see Carbonara et al 2016;Liu et al 2016;Reeves et al 2017;Simon et al 2020), PPP risk exposure (see Chan et al 2018;Jin et al 2021) and revenue uncertainty (see Liu et al 2020;Pellegrino 2021) and guarantees provisions (see for example, Carbonara et al 2015;Wang et al 2018Wang et al , 2019. Thus for example, as relates to tendering, Carbonara et al (2016) developed a PPP decision model that is able to minimize public sector transaction costs.…”