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Seoul Journal of Economics - Vol. 25 , No. 3
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Seoul Journal of Economics - Vol. 25, No. 3, pp. 255-277
Abbreviation: SJE
ISSN: 1225-0279 (Print)
Print publication date 31 Aug 2012
Received 14 Jul 2010 Revised 24 May 2011 Accepted 16 Jun 2012

Optimal Contracts of Public-Private Partnerships with Demand Risk
Daechang Kang
Research Fellow, Korea Institute for International Economic Policy, 246 Yangjaedaero, Seocho-gu, Seoul 137-747, Korea, Tel: +82-2-3460-1166, Fax: +82-2-3460-1044 (dkang@kiep.go.kr)

JEL Classification: D8, H54, H57, L5

Abstract

The paper analyzes the service provision of infrastructure from the aspect of demand risk sharing. The society benefits more under the public-private partnership (PPP) than under government operation, because the government can transfer some risks to private firms through PPP. To reduce total cost, the government is more likely to apply PPP to projects with large risk factors. Using a two-period model, the paper examines the dynamic features of the optimal contract under the PPP. The optimal incentive scheme should be stronger during the second than the first period. As the performance target becomes lower, the incentive power increases in both periods with a higher increase in the first period. As the intertemporal externality becomes stronger, the incentive power increases in both periods with a higher increase in the second period. As the risk or risk aversion increases, the incentive power decreases in both periods, which resembles the static feature.

Keywords: Public-private partnerships, Incentive, Risk sharing, Intertemporal externality
Acknowledgments

I am grateful to the anonymous referees for their helpful comments.

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