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

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.