Abstract: In recent years, public-private partnerships (PPPs) have been widely applied to infrastructure projects in China. Due to the great financial risks of PPP projects, the government often provides guarantees for these projects to attract private participation. However, although the guarantee reduces the cost of the debt, it may also lead to opportunistic behaviors on the part of the private company. Focusing on the renegotiation between project company and the bank when project risk occurs, the debt contract for a PPP project is formulated in the form of an incomplete contract model and the impacts of government guarantee on both ex-ante (before the renegotiation) and ex-post (after the renegotiation) efficiencies of the project are analyzed. Ex-ante efficiency loss caused by asset substitution may arise from incompleteness of debt contract and limited recourse of project financing. Meanwhile, ex-post efficiency loss arises from project termination, when the project company has failed to meet its debt obligations and cannot obtain additional loans from the bank. First, basic model investigates conditions that trigger the ex-ante asset substitution and ex-post project liquidation in the incomplete debt contract, via which the project company determined by a competitive bidding raises project funds. Based on the basic model, how the government guarantee influences the ex-ante and ex-post efficiencies of the project in government guarantee model is analyzed. Furthermore, contractual deposit system is introduced to improve the effects of government guarantee. The results indicate that competitive bidding cannot prevent the occurrence of both asset substitution and project termination. Although government guarantees can avoid ex-post project termination, they cannot prevent asset substitution. Therefore, the government should take the tradeoff between ex-ante efficiency loss and ex-post efficiency improvement into account when adopting the government guarantee. Finally, it is found the contract deposit system is complementary to the government guarantee to improve the social efficiency as well as the financial efficiency. The results obtained in this paper provide a theoretical support for the implementation of PPP projects.

Key words: PPP, incomplete contract, asset substitution, government guarantee, deposit