Credible Commitments: Using Options to Support Partnerships
30 Pages Posted: 22 Dec 2010 Last revised: 31 Dec 2012
Date Written: December 30, 2012
Opportunism --- either governmental hold-up by unfair regulation and expropriation, or private monopoly pricing and investment and quality curbing --- is a powerful deterrent from successful-to-be public-private partnerships with large sunk investments and welfare externalities. The agents can overcome this double-sided moral hazard by exchanging an exit (put) option for the investor and a bail-out (call) option for the public agent on the investor's outlay. The exit/bail-out option mechanism increases the set of payoffs by offsetting deviation, and thus facilitates cooperation. The mechanism is applicable to other settings with partially aligned goals and informational asymmetries.
Keywords: Noncooperative Games, Opportunism, Exit and Bail-out Options, Public-Private Partnerships, Contestable Markets
JEL Classification: C72, D23, G32, H54, L32
Suggested Citation: Suggested Citation