From Fixed to State-Dependent Duration in Public-Private Partnerships

A government delegates a build-operate-transfer project to a private firm. In the contracting stage, the operating cost is unknown. The firm can increase the likelihood of facing a low cost, rather than a high cost, by exerting costly effort when building the infrastructure. Once this is in place, the firm learns the true cost and begins to operate. We show that, under limited commitment, if the break-up of the partnership is sufficiently costly to the government and/or information problems are sufficiently severe, the contract is not robust to renegotiation unless it has a longer duration when the realized cost is low. This result is at odds with the prescription of the literature on flexible-term contracts, which recommends a longer duration when operating conditions are unfavourable.