A game theory approach for the allocation of risks in transport public private partnerships Francesca Medda * Centre for Transport Studies, Department of Civil and Environmental Engineering, University College London, Gower Street, London WC1E 6BT, United Kingdom Received 21 February 2006; received in revised form 16 May 2006; accepted 30 June 2006 Abstract The process of risk allocation between public and private sectors in transport infrastructure agreements is analyzed as a bargaining process between these two agents. Such a process is modelled with a final offer arbitration game. The idea here is to analyze through a game framework the behaviour of the players when confronted with opposite objectives in the allocation of risks. The model shows that when guarantees have a higher value than financial loss we are confronted with strategic behaviour and potential moral hazard problems. Ó 2006 Elsevier Ltd and IPMA. All rights reserved. Keywords: Public private partnerships; Risk allocation; Transport infrastructure; Strategy 1. Introduction Concerted emphasis has been placed on the develop- ment of means by which the private and public sectors can forge partnerships to provide goods and services tradi- tionally provided by the public sector. These partnerships between public and private (PPPs) find their roots in the policy notions of privatization/deregulation of the 1980s [1]. Among the various consequences springing from PPP agreements is the possibility for the public and private sec- tors to share and allocate risk borne with the investment. The sharing and allocation of risk in PPP agreements assumes greater importance when we examine infrastruc- ture investments such as transport. Transport infrastruc- ture investments are inherently capital-intensive and they often require large sunk investments whereby their recoup may span over a 30-year period. They are immobile; in fact, transport infrastructure investments are particularly cum- bersome to transfer or reallocate elsewhere and, if realloca- tion were possible, it would imply prohibitive transfer costs [2]. However, in the past decade transport investment part- nerships between the public and private sectors have become conventional practice in developed and developing countries. On the basis of the Maastricht criteria (1992), which requires a diversification of funding sources in the development and operation of transport infrastructures, the European Investment Bank (EIB) has supported the development of more than 100 PPP projects, covering multi-sectoral transport investments, in most EU countries for a total amount of signed loans over €15 billion [3].A similar situation is apparent when we observe developing countries. From 1990 to 2001, nearly 2500 private infra- structure projects were implemented by the World Bank in developing countries, of which 662 were transport pro- jects with an investment of $135 billion [4]. The interven- tion of the private sector in transport investment has shifted the responsibility, and thus fragmented the decision process, which in the past was taken on solely by the public sector. Risks associated with the investment therefore assume a crucial role. There are many experiences showing that transport investments are highly sensitive to risk allocation [3–5]. For instance, governments can both enhance and depress 0263-7863/$30.00 Ó 2006 Elsevier Ltd and IPMA. All rights reserved. doi:10.1016/j.ijproman.2006.06.003 * Tel.: +44 20 7679 1557; fax: +44 20 7679 1567. E-mail address: f.medda@ucl.ac.uk. www.elsevier.com/locate/ijproman International Journal of Project Management 25 (2007) 213–218 INTERNATIONAL JOURNAL OF PROJECT MANAGEMENT