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We study the effects of granting an exit option that enables the private party to early terminate a PPP project if it turns out to be loss-making. In a continuous time setting with hidden information about stochastic operating profits, we show that a revenue-maximizing government can optimally trade-off direct subsidies for capital investment against the right of opting out the PPP. In particular, the exit option, acting as a risk-sharing device, can soften agency problems and increase the value-for-money of public spending, even while taking into account the budgetary resources needed to resume the project in the event of early termination by the contractor.
Buso, Marco; Dosi, Cesare; and Moretto, Michele, "Termination Fees and Contract Design in Public-Private Partnerships" (December 20, 2018). Fondazione Eni Enrico Mattei Working Papers. Paper 1257.