Government Supports in Public–Private Partnership Contracts: Metro Line 4 of the São Paulo Subway System

Abstract

In November 2005, the state government of São Paulo, Brazil, announced the intention to bid a 30-year contract to build, operate, and explore passenger services for the Metro Line 4 of the São Paulo Metropolitan Subway System. Given the high risk of the project, to attract private investors the bid documents stipulated that the government would offer risk-mitigation mechanisms such as subsidy payments and a minimum demand guarantee (MDG). Because an MDG has option-like characteristics, the real-options approach is used to analyze the effect of these incentives on the value and the risk of the Metro Line 4 concession project, and their cost and risk to the government. The results indicate that the incentives proposed are effective in reducing the risk, and increase the net value of the project by 36% at a cost to the government of 5% of the total value of the project. Additionally, it is shown that for a given cost, the most effective risk-reduction mechanisms are the ones that include a higher portion of minimum demand guarantees relative to the subsidy payment. The approach developed can assist transportation authorities in designing optimal incentive mechanisms.