BOT, Build-Operate-Transfer, is a variation of privatization contracts, in which the government signs a concession contract with the private contractors. A contract in this form permits the private sector to build, operate and maintain an infrastructure project for a period of time. Power station building, toll road construction, water facilities construction are good examples. The contractor should transfer the project back to the government with no reimbursement when the contract expires....[ Read more ]

BOT, Build-Operate-Transfer, is a variation of privatization contracts, in which the government signs a concession contract with the private contractors. A contract in this form permits the private sector to build, operate and maintain an infrastructure project for a period of time. Power station building, toll road construction, water facilities construction are good examples. The contractor should transfer the project back to the government with no reimbursement when the contract expires.

Since the 197Os, BOT has been adopted globally as a method of managing complex and, in many cases, public-concerned projects. Its popularity in most part is due to the heavy fiscal burden placed on governments in the late 20th century. While BOT came in attempting to solve this problem by streamlining responsibilities and clarifying incentives. Since then, BOT has been exposed to extensive and careful reviews in the academic fields of economics and public relationships. As generally accepted, BOT is theoretically an effective way of privatizing public projects in that it aims to benefit all the parties (the government, the contractors, the financial institutions, etc) involved. However, does such kind of "Win-Win" model work in the real world? There are potentially moral hazard problems associated with the private sector because of the ownership structure of the BOT contract. Due to the non/limited-recourse nature of the contract, the contractor, i.e. private owner of the project, can reimburse his investment and gain profit by running the project only during his operation period. So the contractor might abuse the project to make extraordinary profit during the concession period since he has to transfer the project back to the government and lose the control over it.

After analyzing the effort allocation of the BOT contract, we have set up a model and raised an option to cure the potential moral hazard problem in BOT. By introducing an option that the private owner can have some equity share of the revenue the project generated at the following period, no matter whether itself is the owner of the project, the contractor will raise its construction effort and lower its operation effort to avoid abusing the project. We have further compared the efforts level under three different ownership structure, public owned, private owned and BOT. Finally, we made our suggestions.