IESE Research Papers,
IESE Business School

Abstract: Opportunism, either governmental or private, may become a powerful deterrent against public-private project financing, especially considering the scale of the investment in infrastructure. The parties can secure themselves against counterparty opportunism by assigning the investor an exit (put) option and the public agent a bail-out (call) option on the private investor's shares. This paper presents a mechanism for converting natural monopolies into contestable markets using over-the-counter option contracts that combine the stability of long-term contracts and the flexibility of short-term contracts. The exit/bail-out option mechanism reduces entry barriers by streamlining incomplete long-term contracts and avoiding contractual problems related to bounded rationality and opportunism.

Keywords: Opportunism; Public-Private Partnerships; Infrastructure; Natural Monopolies; Contestable Markets; Exit and Bail-out Options; Game Theory

JEL-codes: C72; D23; D42; G32; G38; H54

27 pages, October 15, 2010

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