Optimal Design of Government Guarantee and Revenue Cap Agreements in Public — Private Partnership Contracts

Public–private partnerships (PPP) have been widely used in delivering infrastructure projects as they mobilise social capital to participate in infrastructure construction. However, the long operational period of PPP projects draws high market risks, which deters investment in PPP projects. Government guarantees are frequently used as an investment incentive as they reduce the probabilities of suffering loss for social participants. Nevertheless, government guarantees cannot fully control the overly lucrative conditions for private investors, which is the reason that revenue cap agreements are designed as a supplement in PPP contracts. This research proposes a methodology that can be used to design the specific thresholds for triggering such combined agreements, i.e. government guarantee and revenue cap agreements. These government guarantee and revenue cap decision models adopt geometric Brownian motion modelling as a data analysis tool and the fair preferences in relation to the project profits held by the project parties as an indicator in finding the optimal value of combined agreements. In addition, based on the project parties’ capabilities to bear risk, a self-regulation process for the value of combined agreements is created to ensure the levels of risk borne by the project parties are within their acceptable ranges. The research outcome shows that the proposed methodology in this paper is effective and able to determine the optimal value of government guarantee and revenue cap agreements.