A Study Of Government Ex-post Compensation Mechanisms With Unmet Demand For PPP Projects

Public-Private partnership (PPP) mode is being widely used in developinginfrastructure. This mode emerges largely for merits of relieving public budgetconstraint and improving infrastructure supply efficiency by involving private funds.Under PPP operating revenue is the main means for the private sector to recoupinvestment and obtain profit. However, PPP projects are usually characterized by highdemand uncertainty which may lead to huge loss for the private sector duringoperation. As a result, renegotiation, buyback or even project termination may happenand consequently consumer surplus is also substantially lowered. As a common wayto reduce demand risk the private sector faces, government guarantee ex ante,however, oftentimes fails to be effective in risk-sharing because of imperfection ofdemand estimation when contracting. In this paper ex-post compensation mechanismis proposed. Under this mechanism the private sector is compensated whenuncertainties realize. Therefore, ex-post compensation is more effective in terms ofpayment transfer from the government. Moreover, compensation mechanism can saveon guarantee cost. However, less attention is being paid to the compensationmechanism, which makes it become a pressing problem both in academia and inpractice to explore boundary conditions of ex-post compensation mechanisms toachieve Pareto-improvement of both payoff of private sector and consumer surplus.This research analyzes, by mathematical modeling, the impact of three ex-postcompensation mechanisms–operation extension, demand compensation, and pricecompensation–on payoff of private sector and consumer surplus for PPP toll roadprojects. This research first investigates whether or not these mechanisms can obtainPareto-improvement and, if so, then explores boundary conditions for eachmechanism. The research results show that all of the three ex-post compensationmechanisms can realize Pareto-improvement under certain conditions but theirrespective boundary conditions are different.To be specific, renegotiation costs of both the government and private sectorshould be sufficiently low to achieve Pareto-improvement under all of the threecompensation mechanisms. Moreover, some further conditions should be also satisfied: under operation extension mechanism, the operation cost of the governmentshould be higher than a certain threshold and at the same time the operation cost ofthe private sector should be lower than another threshold; under demandcompensation mechanism, the price cap should be reset; under price compensationmechanism, the compensation percentage should match with the price cut of theprivate sector when demand drops.This research aims to provide theoretical support for the government whenselecting compensation mechanism and determining compensation scope undervarious mechanisms. Moreover, some policy implications can be also drawn from theanalysis for better risk-sharing and sustainability of PPP projects.