The combined effect of marginal social and private benefit on the socially optimal equity structure of PPP projects

Abstract

Although bundling in public–private partnership (PPP) projects fosters cost savings in the provision of public services, such savings might come at the expense of social benefits due to the low quality of non-contractible services and the incompleteness of the contract. A game model is presented to analyse how the equity allocation between private partners—typically, building firms and operating firms—indirectly influences their incentives, in order to improve the quality of non-contractible services. The findings show that the equity structure can effectively compensate for the incompleteness of the contract. When the equity structure is privately negotiated by private partners whose only concern is private benefits, a loss of social benefits due to the low quality of non-contractible services occurs because the penalties are not enforceable. A socially optimal equity structure, which depends on the combined effects of marginal social and private benefits, plays a role in aligning these social and private benefits, thereby providing private partners with appropriate incentives to improve non-contractible services. These findings provide insights into the regulation of the equity structure for PPP projects providing services in diverse sectors.

Keywords:

• PPP projects
• equity structure
• combined marginal benefit
• incentive mechanism
• governance

SUBJECT CLASSIFICATION CODES:

• Public–private partnership
• Incentive contracts
• Project organisation

Acknowledgments

The authors are grateful to Dr. Masamitsu Onishi, Mr. Takao Higuchi, Mr. Masaaki Amma, Mr. Mitsuhiro Yamawaki, Mr. Keigo Sawayama and Dr. Kwangmoon Kim for their helpful suggestions. The authors’ special thanks go to the editors and the anonymous referees for their constructive comments.

Disclosure statement

No potential conflict of interest was reported by the authors.

Data availability statement

All of the data and models that support the findings of this study are available from the corresponding author upon reasonable request.

Notes

1 The effort i may have a negative effect on operating costs. For example, an innovative design of a hospital, using recently developed materials, may lead to improved lighting and air quality, but may also increase maintenance costs. Because the PPP is not a good alternative in this case (Hart 2003), we do not consider this possibility in the paper. For the detail analysis of the negative effects of building investment on operating costs, see Iossa and Martimort (2015).

2 In discussing this issue, Hart et al. (1997) pointed out the obstacles hindering effective ex post competition, including a lack of information, expertise on the part of consumers, and supply constraints, implying that poor performance was not detected or, even if it was, it did not have a perceptible impact on demand.

3 In different countries or regions, governments may have different levels of bargaining power (See Wang et al. 2018). Because the purpose of this study is to investigate the incentive mechanisms of equity structure, we do not consider situations where the government does not have all the bargaining power.

Additional information

Funding

This work was supported by the National Natural Science Foundation of China under Grant 71672017.