Real Option Approach to Sharing Privatization Risk in Underground Infrastructures
Publication: Journal of Construction Engineering and Management
Volume 139, Issue 6
Abstract
Over the last two decades, more than 100 water and sewer systems have been sold or leased to private entities in the United States due to shortages in government funding. While privatization has allowed governments to relieve their financial difficulties, users have taken on such risks in the form of high rates and poor service. When compared to other infrastructures, water and sewer systems generate somewhat stable revenue. However, water and sewer systems are also characterized by the hardly predictable operation and maintenance (O&M) expenses. Such characteristics make it difficult to devise a proper contract that satisfies the interested parties, such as governments, private operators, and users. By investigating the deficiencies of previous privatization contracts, this study presents a real option–based contract model to ensure appropriate risk sharing between private entities and governments. Simulation results based on three different O&M expense scenarios (best, moderate, and worst) indicate that the proposed contract model would provide a win-win situation for all related parties.
Get full access to this article
View all available purchase options and get full access to this article.
Acknowledgments
This work was supported by the National Research Foundation of Korea grants funded by the Ministry of Education, Science, and Technology of Korea (2010-0014365 and 2011-0030841).
References
Alonso-Conde, A. B., Brown, C., and Rojo-Suarez, J. (2006). “Public private partnerships: Incentives, risk transfer and real options.” Rev. Financ. Econ., 16(4), 335–349.
Black and Veatch. (1999). “Optimization of collection system maintenance frequencies and system performance.”, EPA, Washington, DC.
Brandao, L. T. E., and Saraiva, E. (2008). “The option value of government guarantees in infrastructure projects.” Constr. Manage. Econ., 26(11), 1171–1180.
Cheah, C. Y. J., and Liu, J. (2006). “Valuing governmental support in infrastructure projects as real options using Monte Carlo simulation.” Constr. Manage. Econ., 24(5), 545–554.
Chiara, N., Garvin, M. J., and Vecer, J. (2007). “Valuing simple multiple-exercise real options in infrastructure projects.” J. Infrastruct. Syst., 13(2), 97–104.
Copeland, T., and Antikarov, V. (2001). Real options: A practitioner’s guide, CENGAGE Learning, New York.
Cui, Q., Bayraktar, M. E., Hastak, M., and Minkarah, I. (2004). “Use of warranties on highway projects: A real option perspective.” J. Manage. Eng., 20(3), 118–125.
Cui, Q., Johnson, P., Quick, A., and Hastak, M. (2008). “Valuing the warranty ceiling clause on new Mexico highway 44 using a binomial lattice model.” J. Constr. Eng. Manage., 134(1), 10–17.
Dailami, M., and Klein, M. (1998). “Government support to private infrastructure projects in emerging markets.”, World Bank, Washington, DC, 〈http://econ.worldbank.org/external/default/main?pagePK=64165259&&theSitePK=469382&piPK=64165421&menuPK=64166093&entityID=000009265_3980319100128〉.
Food and Water Watch. (2010). “Trends in water privatization.” 〈http://documents.foodandwaterwatch.org/PrivatizationTrends.pdf〉 (Feb. 14, 2011).
Garvin, M. J. (2005). “Real options analysis: Can it improve infrastructure development decisions.” Proc., Construction Research Congress 2005, ASCE, Reston, VA, 501–506.
Garvin, M. J., and Cheah, C. Y. J. (2004). “Valuation techniques for infrastructure investment decisions.” Constr. Manage. Econ., 22(4), 373–383.
Guj, P., and Chandra, A. (2012). “Achieving consistent results from different ROV methodologies: A practical copper mine example.” 16th Annual Int. Conf. on Real Options, Real Options Group, London.
Ho, S. P., and Liu, L. Y. (2002). “An option pricing-based model for evaluating the financial viability of privatized infrastructure projects.” Constr. Manage. Econ., 20(2), 143–156.
Ho, S. P., and Liu, L. Y. (2003). “How to evaluate and invest in emerging A/E/C technologies under uncertainty.” J. Constr. Eng. Manage., 129(1), 16–24.
Karamitsos, D. (2009). “Applying Real Options to Strategies of R&D Portfolio: Comparing model to traditional methods of investments evaluations.” 〈https://edit.ethz.ch/er/publications/MAS-Karamitsos-publication_public_summary_April_2011.pdf〉 (Jun. 9, 2012).
Klein, M. (1997). “Managing guarantee programs in support of infrastructure investment.”, World Bank, Washington, DC, 〈http://econ.worldbank.org/external/default/main?pagePK=64165259&theSitePK=469382&piPK=64165421&menuPK=64166093&entityID=000009265_3971110141353〉.
Leung, N. (2008). “Real options framework for acquisition of real estate properties with excessive land.” Ph.D. dissertation, Univ. of Florida, Gainesville, FL.
Liu, J., and Cheah, C. (2009). “Real option application in PPP/PFI project negotiation.” Constr. Manage. Econ., 27(4), 331–342.
Massachusetts Water Resources Authority (MWRA). (2006). “TRAC (toxic reduction and control)–sewer use.” 〈http://www.mwra.state.ma.us/03sewer/html/tracpermits.htm〉 (Mar. 11, 2011).
McHaney, S. (1992). “Satellite wastewater reclamation plants: How to get what you bargain for.” Desalination, 88(1–3), 215–223.
Miller, J. B. (2000). Principles of public and private infrastructure delivery, Kluwer Academic Publishers, Boston, MA.
New York City Economic Development Corp. (NYCEDC). (2008). “Willets point development plan—Infrastructure.” NYCEDC, New York, NY.
Rose, S. (1998). “Valuation of interacting real options in a toll road infrastructure project.” Q. Rev. Econ. Finance, 38(3), 711–723.
Rockaway, T. D., Coomes, P. A., Joshua, R., and Barry, K. (2011). “Residential water use trends in North America.” J. AWWA, 103(2), 76–89.
Schneider, M., Tejeda, M., Dondi, G., Herzog, F., Keel, S., and Geering, H. (2008). “Making real options work for practitioners: A generic model for valuing R&D projects.” R&D Manage., 28(1), 83–106.
Shan, L., Garvin, M. J., and Kumar, R. (2010). “Collar options to manage revenue risks in real toll public-private partnership transportation projects.” Constr. Manage. Econ., 28(10), 1057–1069.
Trigeoris, L. (1996). Real options: Managerial flexibility and strategy in resource allocation, MIT Press, Boston.
Zaghloul, H. H., and Karaa, F. (1995). Infiltration/inflow mitigation and control for Army wastewater collection systems, Construction Engineering Research Lab, Champaign, IL.
Zhao, T., and Tseng, C. (2003). “Valuing flexibility in infrastructure expansion.” J. Infrastruct. Syst., 9(3), 89–97.
Information & Authors
Information
Published In
Journal of Construction Engineering and Management
Volume 139 • Issue 6 • June 2013
Pages: 685 - 693
Copyright
© 2013 American Society of Civil Engineers.
History
Received: Jul 5, 2011
Accepted: Aug 29, 2012
Published online: Sep 1, 2012
Published in print: Jun 1, 2013
Authors
Metrics & Citations
Metrics
Citations
Download citation
If you have the appropriate software installed, you can download article citation data to the citation manager of your choice. Simply select your manager software from the list below and click Download.