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Contractual flexibility, firm effort, and subsidy design: A comparison of PPP project contracts

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  • Feng, Zhuo
  • Song, Jinbo
  • Yang, Xiaoxing
  • Guo, Ran

Abstract

A growing number of infrastructure projects in developing countries are being provided by private firms through public-private partnership (PPP). We compare rigid and flexible contracts for PPP projects under demand uncertainty, the former of which is not allowed to be adjusted through renegotiation when demand uncertainty materializes while the latter is. In comparing the rigid and the flexible contracts, we highlight their respective strengths of inducing firm effort and adaptation to the uncertainties. We present clear conditions under which each contract type can lead to better performance, measured by firm effort, firm profit, and consumer surplus. We have further investigated the effects of government subsidies on the comparison results. We show that government subsidies are able to improve the comparative advantages of the flexible contract, regardless of subsidy forms. The effects of different government subsidies in improving firm effort to the first-best level under the two contract types are also analyzed.

Suggested Citation

  • Feng, Zhuo & Song, Jinbo & Yang, Xiaoxing & Guo, Ran, 2023. "Contractual flexibility, firm effort, and subsidy design: A comparison of PPP project contracts," European Journal of Operational Research, Elsevier, vol. 307(1), pages 484-496.
    • Handle: RePEc:eee:ejores:v:307:y:2023:i:1:p:484-496
    DOI: 10.1016/j.ejor.2022.09.018
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