Revenue guarantee in public–private partnerships: a win–win model

Abstract

Government guarantees are often granted to increase the viability of the Public–Private Partnership projects, although the use of these guarantees can cause problems if they are not properly set. This paper provides a useful tool to define a proper value of public subsidies. In particular, we develop a methodology to calculate the optimal values of the revenue floor (the minimum amount of revenue secured by the government in the minimum revenue guarantee) and revenue ceiling (the upper threshold of revenue that defines the excess revenue to be shared in the revenue sharing) in a way that creates a “win–win” condition for the concessionaire and the government and fairly shares risk between them. The proposed methodology operationalizes minimum revenue guarantee and revenue sharing as real options. The resulting real option-based model is applied to a real case, namely the Strait of Messina Bridge in Italy. The application shows the usefulness of the model in supporting: (a) the government’s decision-making process on assessing values of public subsidies needed to make the project attractive to private investors; and (b) both public and private parties during the negotiation in finding the fair values of the revenue floor and ceiling.

Keywords:

• Public–private partnerships
• revenue guarantee
• revenue sharing
• risk management
• win–win principle

Notes

1. Lately, however, a new criterion that would require the application of a “control criterion” as the basis for the classification of PPP assets has been introduced. The logic behind this approach is that if a government initiates the construction of an asset, specifies its characteristics and retains the ultimate responsibility for it (i.e. the asset is unlikely to be of use to anyone else) then it “controls” the asset and should report it on its balance sheet (EPEC, 2010).

2. Value at Risk (VaR) is defined as a threshold loss value, such that the probability that the loss on the project over the given time horizon exceeds this value is equal to a pre-defined acceptable level p.