| Abstract: | The possibility of opportunistic behavior, whether by the private investors who operate public‐private projects or by the government agencies who oversee and administer them, can become a powerful deterrent to raising public‐private project financing, especially considering the scale of the investment in infrastructure. Nevertheless, both parties can protect themselves against the counterparty's possible opportunism by giving the investor an “exit” (or put) option and the public agent a “bail‐out” (or call) option on the private investor's shares. In describing the role and design of such puts and calls, this paper presents a mechanism for converting “natural monopolies” into competitive or contestable markets by using over‐the‐counter option contracts that combine the stability of long‐term contracts and the flexibility of short‐term contracts. In the language of economists, the exit/bail‐out option mechanisms presented here are seen as reducing barriers to entry by streamlining incomplete long‐term contracts and avoiding contractual problems related to “bounded rationality” and opportunism. |
