Contract Design And Control Analysis Of Investors’ Escalation Of Commitment In PPP Projects

In recent years,the demands for infrastructure and public utilities has spurred the rapid development of public-private partnership(PPP)schemes.However,the development of PPP has fallen into a dilemma in practice,which is closely related to the decision-making behavior of stakeholders.As the key nodes connecting governments and financial institutions in PPP projects,investors directly determine the project performance and even the success to some extent.When receiving negative consequences in PPP projects,for instance,a serious decrease of traffic demand,severely delayed schedule and poor operational performance,investors often behave irrationally and choose to continue the projects,and then escalation of commitment(EOC)occurs.Once the investors escalate their commitment to PPP projects,their decision-making may result in irreversible great losses to stakeholders and even to the whole projects.Therefore,focusing on the results caused by escalation behavior of investors in PPP projects,this research analyses the contract design in different EOC scenarios and control measures.The findings will serve as a reference for both governments and investors,and also make important theoretical and practical contributions to the sustainable development of PPP arrangements.First,the different contracts for EOC displayed by investors are designed.The EOC scenarios are divided into three types according to the role of governments,and the escalation behavior generally present active and passive modes due to different risk preferences of investors.Afterwards,the optimal contracts between governments and investors with the tendency to EOC are formulated using the principal-agent theory.The introduction of the investors’ willingness to escalation can effectively coordinate the benefit distribution between the both sides,and further promote to reach agreement on contract design for EOC during renegotiations in PPP projects.Next,the selection of government supervision mode in PPP projects with investors’ EOC is analyzed.When investors choose to persist with losing course of action and commit more resources to PPP projects,this thesis addresses the issue of the government supervision selection from the perspective of the administration and supervision using evolutionary game theory.The results show that government supervision mode is closely related to the revenue obtained during the first stage,as well as the probability of identifying investors’ breach of contract through outcome-oriented supervision.The less the revenue of investors having acquired,the more the sunk cost,the higher the likelihood of default when investors escalate commitment in PPP projects.The study of the government supervision mode in an EOC scenario from an external supervision perspective,complements the contract design,providing a reference for efficient governance to control investors’ escalation behavior.Then,a termination threshold model for investors’ EOC is constructed.Specifically,the maximum amount of negative feedback that investors can sustain is illustrated based on a belief-adjustment model,followed by some discussions about the greatest degree of losses.And then the termination threshold model is developed using real option thinking and further the value of PPP projects with an abandonment option in EOC situations is determined.These findings contribute to the development between escalation behavior and option decisionmaking.Furthermore,this thesis studies the pricing mechanism in investors’ EOC scenario of PPP projects.Early termination initiated by investors is usually unpredictable and inevitable due to various uncertain risks under such EOC circumstances despite of typical contract designs in place during the concession period.Consequently,using the real option theory,different pricing mechanisms for investors with different risk preferences in the three EOC scenarios are constructed.The price quantification and derivation of early termination caused by investors’ escalation behavior serves as a valuable benchmark for both governments and investors essentially,and helps achieve a fairer risk allocation in PPP projects.Eventually,based on the above results,some recommendations for controlling investors’ EOC are proposed in terms of governments and investors respectively,aiming to improve the governance system of PPP projects.Different from the existing literature on the objective risks in PPP projects,this research studies a subjective escalation behavior of investors,and the contributions focus on four aspects.From the perspective of the risk caused by investors’ subjective behavior,the analysis concentrates on the EOC exhibited by investors in PPP projects.Specifically,when constructing the principal-agent models in the presence of escalation tendencies in investors in PPP projects,both the distribution of the outcomes after EOC and the risk preferences of investors are considered.As a result,the designed contracts are more easily accepted by both parties during renegotiations faced with the on negative feedback of PPP projects.Second,discriminating from the analysis performed by literature on the governance of default from the contract incentive point of view,the government supervision mode is discussed in investors’ escalation behavior.The appropriate government supervision is conducive to choose optimal strategies for both parties and further reduce the negative impacts.Next,different from the normal judgment criteria of traditional option theory,in an EOC scenario the critical condition that investors terminate the projects is no longer that the project value with an option being equal to zero.Instead,a certain level of losses is acceptable,namely,the termination threshold for investors’ EOC is less than zero in PPP projects.Finally,more attention is paid to the quantification and derivation of prices when investors initiate early termination due to the escalation behavior in PPP projects.Different pricing mechanism of early termination for investors’ EOC using real option theory helps investors withdraw from the projects smoothly to avoid meaningless disputes.To sum up,this thesis studies investors’ EOC in PPP projects to analyze the contractual arrangements and control measures.From a theoretical perspective,the study helps to supplement the existing literature on objective factors and improve the governance system of PPP projects.Inspired by the thinking way of real option theory,the termination threshold and pricing mechanism for investors’ EOC are presented,which extends the application of traditional real option to subjective behavior and also enriches the relevant research regarding PPP projects.Accordingly,the designed contracts are conducive to reach a consensus agreed by governments and investors during renegotiations when facing negative feedback from the view of the practice.Effective renegotiations and contract management can promote the collaboration between the both sides.Once the investors choose to escalate their commitment,appropriate government supervision mode can curb potential default of investors to improve the management performance in such EOC scenario.The research on termination threshold and pricing for investors’ EOC are exactly helpful to address the early termination issue accurately to avoid further losses.The study on investors’ EOC in PPP projects can contribute to reduce the risks of both governments and investors and also make their decisions more reasonable,thereby helping to achieve more effective governance of PPP projects.