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From fixed to state-dependent duration in public-private contracts

Daniel Danau () and Annalisa Vinella ()

Economics Working Paper Archive (University of Rennes 1 & University of Caen) from Center for Research in Economics and Management (CREM), University of Rennes 1, University of Caen and CNRS

Abstract: A government delegates a build-operate-transfer project to a private firm. At the contracting stage, the operating cost is unknown. The firm can increase the likelihood of facing a low cost (the good state) by exerting effort when building the infrastructure. Once this is in place, the firm learns the true cost and begins to operate. Under limited commitment, either the firm or the government may renege on the contract. Within this context, we explore how well a contract with a state-dependent duration performs, as compared to the more standard fixed-term contract. Under full commitment, the efficient allocation is decentralized, whether the contractual term is fixed or state-dependent. Under limited commitment, in situations where break-up of the partnership is little costly for the government, the efficient allocation can be decentralized only if it is stipulated that the duration of the contract will be longer in the good state than in the bad state. This result is at odds with the prescription of the literature on "flexible-term" contracts, which recommends a longer contractual length when the operating conditions are unfavourable.

Keywords: Fixed-term contract; state-dependent duration; limited commitment; renegotiation; public-private partnerships (search for similar items in EconPapers)
JEL-codes: D82 H57 H81 (search for similar items in EconPapers)
Date: 2013-12, Revised 2015-01
New Economics Papers: this item is included in nep-bec, nep-cta, nep-mic and nep-ppm
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Persistent link: https://EconPapers.repec.org/RePEc:tut:cremwp:201344

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