The public-private partnership valuation paradox

Abstract

Purpose In the context of public-private partnerships (PPPs), it has been argued that the standard valuation framework produces a paradox whereby government appears to be made better off by taking on more systematic risk. This has led to a range of approaches being applied in practice, none of which are consistent with the standard valuation approach. The purpose of this paper is to demonstrate that these approaches are flawed and unnecessary. Design/methodology/approach The authors step through the proposed alternative valuation approaches and demonstrate their inconsistencies and illogical outcomes, using theory, logic and mathematical proof. Findings In this paper, the authors demonstrate that the proposed (alternative) approaches suffer from internal inconsistencies and produce illogical outcomes in some cases. The authors also show that there is no problem with the current accepted theory and that the apparent paradox is not the result of a deficiency in the current theory but is rather caused by its misapplication in practice. In particular, the authors show that the systematic risk of cash flows is frequently mis-estimated, and the correction of this error solves the apparent paradox. Practical implications Over the past 20 years, PPP activity around the globe amounts to many billions of dollars. Decisions on major infrastructure funding are of enormous social and economic importance. Originality/value To the best of the authors’ knowledge, this study is the first to demonstrate the flaws and internal inconsistencies with proposed valuation framework alternatives for the purposes of evaluating PPPs.