Transportation Research Part E 67 (2014) 162–174

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Transportation Research Part E

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Incentive approaches to overcome moral hazard in portconcession agreements

http://dx.doi.org/10.1016/j.tre.2014.04.0081366-5545/� 2014 Elsevier Ltd. All rights reserved.

⇑ Corresponding author. Tel.: +1 409 740 4496; fax: +1 409 741 4017.E-mail addresses: wangw@tamug.edu (G.W.Y. Wang), apallis@aegean.gr (A.A. Pallis).

Grace W.Y. Wang a,⇑, Athanasios A. Pallis b,c

a Department of Maritime Administration, Texas A&M University at Galveston, 200 Seawolf Parkway, PO Box 1675, Galveston, TX 77553-1675, USAb Department of Shipping, Trade & Transport, University of the Aegean, 2 Korai St, 82 100 Chios, Greecec MedCruise 10, Akti Miaouli str. Piraeus 18538, Greece

a r t i c l e i n f o

Article history:Received 3 October 2013Received in revised form 18 March 2014Accepted 18 April 2014

Keywords:Port terminals concessionsPerformance-based concessionIncentivesMoral hazard

a b s t r a c t

This paper provides a game theory foundation for port concession agreements, using theincentive mechanism design. This study identifies the post contractual moral hazard prob-lem, and provides a model involving performance-based concession fees to align success-fully the Port Authorities’ interests with those of the terminal operators. To match theoryand practice, factual information of recent projects in Europe and the US is reviewed. Evi-dently, to avoid transaction failures in a Greenfield concession, the port authority needs toidentify clearly the objectives undertaken. The port should have the ability to enforce thecontract and determine the process of quality assurance.

� 2014 Elsevier Ltd. All rights reserved.

1. Introduction

Concession contracts are the dominant modes of private business entry in seaport operations. A substantial part of portauthorities’ income is from concession fees (i.e. 30% in Italy – Parola et al., 2012). These contracts and concessions can resultin the outsourcing of functions such as terminal management, terminal operations, marketing, security, waterside mainte-nance, and land acquisition and disposal to the private sector due to labor force, fiscal, or risk management considerations. InUS, port authorities practices generally involves the transfer of rights to provide port services, rather than moving assetownership to a private port terminal operator (Talley, 2009). By comparison, in Europe, a study of 116 European ports thatawarded container terminals concessions found that approximately 40% of awarded ports completed in the period 2003–2010 (Notteboom et al., 2012).

In a review of 781 terminals globally, Farrell (2012) demonstrated that a common practice regarding the awarding pro-cedure does not exist. Awarding procedures and leasing schemes differ between regions, within countries, even within agiven port. In Rotterdam, dual practices exist as calls for tenders are combined with direct talks with incumbents (DeLangen et al., 2012). Others such as Greece and China see corporatization and Stock Exchange listings as a preconditionfor increasing private sector investment (Psaraftis and Pallis, 2012). Other fast-grow ports in China operate in the form ofjoint ventures, in which public sector operators retain a share of at least 75% and port corporations operate as commercialentities. Disregarding the difference of the awarding seaport terminals to private sectors, the theme of awarding terminalconcessions has become an important expanded area of port studies (Notteboom et al., 2012). Theys et al. (2010) detailed

G.W.Y. Wang, A.A. Pallis / Transportation Research Part E 67 (2014) 162–174 163

a research agenda of issues emerging at various stages of the awarding process. One of the issues was the examination ofasset allocation and risk distribution between Port Authorities (PA) and terminal operators (TO).

Current research has often been limited to an examination of the relationship between the principles (PAs) and the agents(TOs). Asymmetry resulted in a contract does not allow the PA to control or monitor the TO behavior effectively. Due toasymmetric information, there is a risk that the TO might engage in activities that are undesirable from a PA’s standpointafter the concession agreement is signed. This is known as the moral hazard problem. During the implementation of seaportconcession, the principal can no longer specify choices, the activities of the agent are not observable, and the actions takenare not easily verifiable. A conflict over which actions should be taken might emerge. Moral hazard can be present any timeas the TO might wish to take unforeseen risks or to gain from acting contrary to the principles envisaged by the PA. Weintend to develop a framework that allows overcoming the moral hazard problem rooted from the asymmetric informationof the two parties at the time of contracting.

Niu and Zhang (2013) studied the impact of demand uncertainty on the build-operate-transfer (BOT) contract. The studydiscussed the incentive of the public and private sector in maximizing social welfare and found that the length of the con-cession, optimal capacity, and service quality of the infrastructure depend on the operating costs and negotiation power.Kang et al. (2012) compared concessionaire’s profit index to study royalty negotiation for BOT projects. The public sectorcollected royalty when the private sector received excessive profit and stopped/renegotiated royalty when the private sectorexperienced financial difficulty. The paper emphasized how the learning effect, concession rate, and discount factors on thebargaining process impact which royalty model is best suited to the government sector and to the concessionaires.

However, the studies discussed above do not present an analytic solution for moral hazard rooted from the asymmetricinformation. Our focus on this paper is not the optimal investment in transportation capacity, but to point out the incentiveissues and possible conflict of interests between the concession parties – port authority and terminal operators. To do so,using a simplified fixed cost to capture royalty charge, we incorporate the unique features such as an upfront lump-sum pay-ment, throughput guarantees, and/or passenger guarantees in a game theory application. We also emphasize the importanceof the incentive compatibility constraint in aligning a terminal operator’s objective to what is desirable for the port authority.

Concession contracts may take many forms. BOT projects the most common form of Public–Private–Partnership (PPP).Kang et al. (2013) studied royalty bargaining in the PPP using a three-stage game theory model with bidding, bargaining,and payoff realization. The authors discussed famous PPP projects such as the Euotunnel project, France Euro Disneyland,Taiwan’s high-speed rail, Malaysia’s highway, and Mexico’s toll road. However, PPP applications of maritime sectors in gen-eral and seaport in particular are hard to find in academic research. To our best knowledge, especially in regards to the casesof concession or PPP in the US seaport/terminal, they have rarely received the attention of the academic literature. Given thefact that research on US seaport concessions is surprisingly limited, we provide evidence on US seaport concessions to showthe current status of the private sector involvements in the much needed maritime transportation field.

Compared to seaport concession and/or PPP, air transport has been studied extensively in the literature. Zhang and Zhang(1997) studied the effects of aeronautical changes and concession revenue on optimal pricing for airport operations. Theyfound that cross subsidy from concession commercial operation to aeronautical activities can reach the second-best solutionin maximizing social welfare. D’Alfonso and Nastasi (2012) studied various types of vertical agreements between airport andairlines including no contract, vertical collusion, upstream competition, and price discrimination in the air transport. Theyfound misalignment between the private sector and the social incentives led to inefficiency. Barbot et al. (2013) providedthe sufficient condition to detect vertical collusion in a game theory model. They empirically tested 36 pairs of Europeanairports-airlines and found national flag airlines will collude in hub airport and low cost carriers will choose the secondaryairports.

This study provides a game theory foundation to address the moral hazard problem. Non-port economic theory arguesthat placing of responsibilities during contracting can reduce moral hazard. By using an incentives mechanism design toexplain the performance incentive of a concessionaire, this study identified further the post contractual moral hazard prob-lem, and provided a model involving performance-based concession fees to align successfully the PA interests with those ofthe TO.

Aiming to develop some realistic managerial suggestions, the last part of the study turns on evidence from the field. Fac-tual information of recent projects in ports in Europe and the US provides evidence about which incentive mechanisms aredesigned in the respective agreements. With the findings suggesting that contrary to economic theory and the foundationsestablished via the model the presence of incentive mechanisms is limited, the paper provides managerial and policy recom-mendations accordingly.

2. Theoretical and practical foundations for developing an incentive approach

Concession agreements in seaports are driven by various factors. These factors include introducing market-oriented pub-lic management, technical and cost efficiencies (cf. Wang and Knox, 2011; Wang et al., 2013), and access to capital marketsto finance port construction and development. These agreements imply a risk sharing over the life of the contract. The will-ingness of the agent (TO) to provide port services does not mean their interests are automatically aligned with those of theprincipal (PA) (Notteboom, 2007). Therefore, in practice there has been a high percentage of costly contract renegotiationdue to a poorly-designed contract in transportation sectors and seaports (Guasch, 2004).

164 G.W.Y. Wang, A.A. Pallis / Transportation Research Part E 67 (2014) 162–174

Contractual provisions provide relevant incentives to both involved parties. The design of optimal incentive contracts hasbeen studied extensively in the literature of economic theory. As early as Holmstrom (1979, 1982), Baron and Besanko(1984) and Dewatripont (1986), renegotiations of optimal contracts, incentives, and necessary auditing and regulationsare discussed in the environment with moral hazard. Laffont and Tirole (1993) extended the theory of incentives to the caseof implicit incentives in a dynamic setting with agency conflicts. Given that the first-best outcome to deal with moral hazardwas achievable depended on the timing of contracting, a risk-neutral or risk-averse agent, and the setting of complete infor-mation, Tirole (1999) noted that the proper allocation of rights ensured the binding of the incentive constraint. Laffont andMartimort (2002) discussed the setting with limited liability, meaning minimum effort required by the agent, in a discretecontinuum of performances. Guasch et al. (2008) reviewed the optimal form of awarding and rewarding contracts, renego-tiations, incompleteness of contract due to unforeseen transaction costs, and the imperfect enforcement of contracts.Scandizzo and Ventura (2010) concluded that renegotiating prices periodically can successfully align incentives betweena public and a private agent.

In the port sector, the importance of contractual commitments was not acknowledged in practice. Minimum throughputguarantees play an important role in structuring seaport concession agreements (Pallis et el., 2008). According to Notteboom(2007), throughput guarantees were a powerful governance tool for PAs that secured reasonable land productivity, condi-tionally lowered the entry barriers to newcomers, and provided necessary incentives to TOs to increase terminal utilizationrates.

What has not been extensively examined, however, is how the structure of concession fees impact risk transferringbetween PAs and TOs and the incentive of post-contract monitoring (avoidance of moral hazard). Cruz and Marques(2012) were among the few that explored commercial risk-sharing between PAs and TOs and the resulting close correlationto the pricing strategy. A concession fee paid upfront as a fixed amount resulted in a fully insured PA that is less likely tomonitor the behavior of the TO. Theys et al. (2010) advocated the need for further research to clarify whether low concessionfees might require the installation of performance targets, while high concession fees might make performance targetsredundant.

While the application of contract theory in port studies remains pending, performance incentives in the concession con-tract have been extensively studied in other industries. The relevant literature includes pricing/fees as a key incentive mech-anism. Crampes and Estache (1998) discuss the trade-offs in the optimal design of concession contracts in infrastructure,electricity and water industries. In determining pricing and awarding process, regulators have to use not only the ex postcosts, but also the private information from the managers. Similarly, Albalate and Bel (2009) emphasize the importanceof the assignment of risks and incentives in concessions of infrastructure due to huge sunk costs and uncertain demands.Their simulation of Spanish toll motorways shows how well a flexible concession outperformed the fixed length one. Toovercome the potential pitfalls in a fixed length concession, Engel et al. (2001) proposed a mechanism known as the leastpresent value of revenues. Once the accumulated toll charges meet the target, the concessionaire receives the toll revenues.Nombela and De Rus (2004) also propose a flexible-term contract in determining the optimal mechanism to avoid costlyrenegotiations of contracts.

Scholars studying corporate finance suggest that the standard moral hazard model can be addressed with the use of gametheory. Jensen and Meckling (1976) and Jensen (1986) discussed how the contracting stage was the appropriate time toresolve conflicts of interest. Fama (1980) and Holmstrom (1999) investigated whether soft information such as past perfor-mances and reputation were sufficient in inducing the first-best effort. Jensen and Murphy (1990) and Prendergast (1999)studied the trade-off between risk and incentives in predicting outcomes. This raises the question of whether a similar modelfocusing on the performance incentives in a concession agreement identify and resolve the moral hazard problem between aTO and a PA.

3. Developing a Performance incentives mechanism design

While examining the development of an agent-based incentive mechanism design for port concessions, it is worthacknowledging up front that the principal (the PA) is involved in the game with multiple objectives and revenue streams,which are influenced by its organizational structure and function performed. World Bank Port Toolkit (2001) provideddistinction between service, tool, and landlord PAs. It is important to recognize the distinction between the regulatoryand operating functions, the multiplicity of targets (Brooks and Cullinane, 2007), and the modern PA for exercising ‘‘beyondthe landlord’’ function, especially in the cargo sector where integration to supply chains is a key competitiveness sector (Vander Lugt and de Langen, 2007; Verhoeven, 2010).

In the absence on an explicit optimization model for the PA, this study focuses on a widely developed practice of the land-lord PA in the US. The PA maintains mainly the responsibilities of developing, planning, and marketing strategies while theoperators (agents) handle cargo services, pilotage, line handling, facility maintenance, etc. From the large samples and surveyof landlord PAs, the expected throughput stands as the most important performance-based incentives in the selection pro-cess (ESPO/ITMMA, 2008; ESPO, 2011; Notteboom et al., 2012). Therefore, in this study the maximum throughput is exam-ined as the implicit objective for the PA. Based on the mission of US port authorities, the policy objectives are typicallyeconomic well-being, local development, and employment. Following this assumption in order to develop a theoreticalmodel, that can be used in future research, the objectives of a PA are to increase throughput volumes, attract international

G.W.Y. Wang, A.A. Pallis / Transportation Research Part E 67 (2014) 162–174 165

trade, and maximize market shares. Thus, maximizing throughput would serve as a proxy for the stated objectives of US portauthorities. The long-term development plan of a PA fulfills the operational needs and functions that could conflict with theaim of the agent (the TO), which is to maximize profit.

From a standpoint of the contract design, performance targets may be redundant to the high concession fees if the marketis perfectly competitive, meaning that a large number of existing TOs offering undifferentiated services compete with eachother with a limited ability to deviate from the equilibrium prices. Given a fixed charge per unit of throughput handled, aTO’s revenue stream is maximized through increasing quantity, coinciding with the PA’s interest. Since both parties havecommon interests, there is no incentive for the agent to deviate. Hence, it could be true that high concession fees make per-formance targets redundant. The picture is quite different in the real world however, where long-term concession agree-ments might create entry barriers for new operators and even allow for excess rent-seeking (Goss, 1999; de Langen andPallis, 2007). Thus the danger of moral hazard problems exists.

Suppose that a TO has certain control of the cargo handling fees in a hypothetical terminal. The pricing strategy is tied tothe quantity of services provided. If port users are relatively price inelastic, meaning that port users have few alternativesto choose from (captive users) and thus are less sensitive to increasing price, the best strategy for a profit maximizing TOis to reduce the amount of services and increase the charge per unit.

As illustrated in Fig. 1, a monopolistic or a monopolistic competitive TO intends to charge a higher cargo-handling fee (e.g.rise from Pcom to Pmono). The annual throughput, Qmono, is determined when the incremental revenue of producing more ser-vice (MR) is equal to the additional cost to provide it (MC). A rent-seeking pricing mechanism conflicts with the interest ofthe port users, thus resulting in less demand for port services (e.g. from Qcom to Qmono). Misallocation of resources leads toinefficient production for the society. As a result, without a well-developed incentive scheme for a TO, the PA’s objectives ofmaximizing productivity in terms of throughputs, market shares, and terminal utilization rates will not be achieved.

The situation of imperfect competition described above could result from (1) the government-granted exclusive right in aconcession agreement to operate a terminal; (2) the economies of scale produced by a single TO along the decreasing long-run average cost curve; (3) product differentiation, meaning that each TO provides services to fulfill the needs of differentport users and shippers; and (4) the strategic interdependence of a few dominant TOs in which the best pricing strategydepends on the behavior of others in the group.

In this study, the incentive scheme is considered in the simplest case when a PA forms a concession agreement with asingle TO, as describe in cases 1 and 2 above. The model can be extended to multiple TOs in the situation of monopolisticcompetition, case 3, and oligopoly, case 4, in a Bertrand duopoly model.

4. Model and findings

The key feature of the model is the TO’s private information about its influence on the quantity of services the hypothet-ical terminal receives. Total throughputs handled and a PA’s welfare are affected to a great extent by the TO’s actions. Byundertaking careful allocation of physical facility and the resources it has (whether means of production or networking capa-bilities) a TO could enhance the quality of services, terminal utilization rates, and thus the competitiveness in terms ofthroughputs. However, the managerial effort creates a cost burden on the TO. When a TO’s efforts are not observable, theconcession agreement can no longer specify them in an effective manner. It is difficult for a PA to verify whether a TOhas fulfilled its obligations effectively in increasing the terminal utilization rates. The situation in which asymmetries ofinformation exist between individuals after the contract is signed is known as moral hazard.

4.1. The behavior of a representative TO

The payoffs of a TO in a concession agreement of n periods is determined by the unobservable efforts e in increasingthroughputs, q, where q0(e) > 0 and q00ðeÞ ¼ 0. A higher effort leads to a greater throughput quantity. If the managerial effort

Pcom

Pmono

MR Demand

Cost; Price

Annual Throughput

MC

Qcom Qmono

Fig. 1. Illustrative conflict of interests between PA and TO.

166 G.W.Y. Wang, A.A. Pallis / Transportation Research Part E 67 (2014) 162–174

is made, the TO provides services qðeÞ > q, where q is the minimum throughput guarantee imposed by the PA. Otherwise, thethroughputs handled by the operator will be below the performance target, qð0Þ < q, and a TO may face penalty of early sus-pension of the concession contract.

A TO is a profit maximizer with a profit function p(p, e) over its pricing strategy of cargo handling fees p and effort level e.A TO prefers a higher charge per unit of cargo handled and dislikes a higher level of effort due to the rising cost c(e), wherec0(e) > 0 and c00ðeÞ ¼ 0. c(0) = 0. If the demand for port services is relatively inelastic, a TO can increase cargo handling feeswithout losing its customers. Under competition, however, TOs cannot change the equilibrium price through quantity con-trol. Pricing strategy simply reduces to p ¼ �p, where �p is a fixed price per unit, and TOs take this information as given. Theyare price takers.

The payoffs of a TO with the unobservable effort in the initial period of the concession is

p1ðp; eÞ ¼ pðqðeÞÞqðeÞ � v1qðeÞ � F � cðeÞ ð1Þ

A TO’s profit is the difference between revenue and costs. The multiplier of unit price charged p(q) and the quantity pro-vided q(e) is the revenue. p(q) is governed by the demand curve of the port users, p(q) = a � q, where a is a constant term andq is the quantity. The costs can be decomposed into (1) variable cost v1q(e), such as royalty fees and operating costs whichvary as the quantity increases at a rate v1; (2) fixed cost F, such as concession fees and initial investment; and (3) the cost ofmanagerial efforts c(e).

TO’s behavior and cost structure should be determined by complex objectives. We observe the increasing concentration ofthe global TOs who are involved in seaport concessions. The market share in terms of total throughput handled by the tenleading TOs increased to 64.6% in 2009 from 41.5% in 2001 (Drewry, 2012). The scale of vertical and horizontal integration isimportant for analysis of profitability. The former increases the synergies of other business interests or product diversifica-tion and emphasizes the link of terminal operating and stevedoring to the maritime shipping services. The latter focuses onthe company take-over, merger and acquisition to consolidate market share. Different types of TO imply different objectivesand dissimilarities including cost differentials, governance, management strategies, and spatial competition; all determi-nants of TO’s profitability (Slack and Fremont, 2005) might influence the effectiveness of the incentive schemes.

In the model, the overall concession fee is a lump-sum amount paid at the beginning of the contract. Thus, the profit func-tion since the second period, p(q), would be the same as p1(q) defined above except the concession fees F. If we consider thesimplest case with only one period of concession, the first order condition (FOC) for the profit-maximizing TO is

@p1

@e¼ pðqðeÞÞq0ðeÞ þ p0ðq0ðeÞÞqðeÞ � v1q0ðeÞ � c0ðeÞ ¼ 0 ð2Þ

¼¼)FOC¼0

pq0ðeÞ þ @p@q:@q@e

� �q ¼ v1q0ðeÞ þ c0ðeÞ

! q0ðeÞ þ @p@q:qp

� �@q@e¼ 1

p½v1q0ðeÞ þ c0ðeÞ�

! pq0ðeÞ 1þ 1Ep

� �¼ ½v1q0ðeÞ þ c0ðeÞ�

where the price elasticity of demand, Ep � @p@q �

qp, indicates how sensitive port users respond to price changes. For a normal

good, Ep is always less than zero, showing the law of demand, a negative relationship between the price per unit and thequantity demanded.

Proposition 1. If Ep < �1, an interior solution for e exists when MR = MC. Otherwise, a corner solution is obtained for a profit-maximizing TO.

It is important to note how price elasticity of demand influences a TO’s optimal decision to choose effort level. If themarket demand is relatively elastic, Ep < �1, there exists an interior solution for e. As is shown in Eq. (2), when the marginalrevenue on the left hand side is equivalent to the marginal cost on the right hand side, the optimal effort of a TO is deter-mined. On the other hand, if the demand faced by the TO is relatively inelastic, Ep 2 (�1, 0), the FOC becomes negative. Acorner solution, meaning that the best choice for a TO is to make no effort at all, is obtained as the solution for the agent’smaximization. The result is consistent with the economic intuition. If there is no close substitutes available for port users, theTO tends to pay no effort to improve the quality and charge a higher price per unit of service provided.

The second order condition (SOC) for a profit maximization problem is

@2p1

@e2 ¼ pq00ðeÞ þ p0q0ðeÞ þ p00qðeÞ þ p0q0ðeÞ � v1q00ðeÞ � c00ðeÞ ð3Þ

Recalling that q00ðeÞ ¼ 0, c00ðeÞ ¼ 0, and p00ðeÞ ¼ @@e ð

@p@q

@q@eÞ ¼ �q00ðeÞ ¼ 0, the SOC can be rewritten as p0q0ðeÞ þ p0q0ðeÞ < 0. Thus,

a TO’s profit maximization behavior is ensured.

G.W.Y. Wang, A.A. Pallis / Transportation Research Part E 67 (2014) 162–174 167

4.2. Incentive compatibility constraint under asymmetric information

As shown, one possibility for a TO to maximize profit in a one-period game is to make no effort. Due to asymmetric infor-mation, there is a risk that the TO might engage in activities that are undesirable from a PA’s standpoint after the concessionagreement is signed. This is known as the moral hazard problem. It is more likely to happen when a TO’s action is privateinformation and unobservable to other players in the game. To combat the moral hazard problem, an incentive scheme needsto be introduced in a way that indirectly guides the TO to choose the correct action.

Suppose that a TO is engaged in a n-period concession contract with a PA. The present value of the income stream over then-period of concession is

p1ðp; e�Þ þpðp; e�Þð1þ rÞ þ

pðp; e�Þð1þ rÞ2

þ pðp; e�Þð1þ rÞ3

þ � � � þ pðp; e�Þð1þ rÞn�1 ð4Þ

where r is the market interest rate, serving as a discount factor of the future cash flow, and e⁄ is the optimal level of effort. Amonopolistic TO, however, can deviate from what is desirable for a PA by making no effort in managing terminal operationsand start charging a high price in the middle of the concession period at time t. If a TO chooses to cheat, the payoff in period twill be

pcðpð~qÞ; eÞ ¼ pð~qÞ~qð0Þ � m1~qð0Þ � cð0Þ; ~q < q ð5Þ

where ~q is the throughput below the imposed minimum throughput guarantee, q. By doing so, a TO benefits from cost savingand rent-seeking behavior. As illustrated in Fig. 1, no further profit opportunity will be available if the market is closed toperfect competition. A profit making TO has incentives to prevent this from happening. A rent-seeking strategy includes pro-visions for a limited amount of services and increasing unit charge.

Quantity reduction comes from aggressive pricing strategies and/or poor quality due to mismanagement and waste ofresources. If a TO exerts no effort and fails to provide production efficiency, throughputs will drop below the performancetarget. The minimum throughput guarantee will not be met. The PA thus terminates the concession agreement early at per-iod t. Once the contract is suspended, a TO receives nothing afterwards. The present value of the income stream of a TO thatcheats at period t is:

p1ðp; e�Þ þpðp; e�Þð1þ rÞ þ

pðp; e�Þð1þ rÞ2

þ � � � þ pcðp; e�Þð1þ rÞt�1 þ 0þ � � � þ 0|fflfflfflfflfflfflfflffl{zfflfflfflfflfflfflfflffl}

n�t

ð6Þ

If the increases in profit due to quantity increases is greater than the proceeds of one-time cost saving and rent-seeking, itis desirable for a TO to behave in accordance with the contract agreement’s incentive scheme.

pðp; e�Þð1þ rÞt�1 þ � � � þ

pðp; e�Þð1þ rÞn

>pcðp; eÞð1þ rÞt�1 ð7Þ

The condition above is the incentive compatibility (IC) constraint, ensuring a TO is motivated to engage in activities thatimprove the quality of port services. We can rewrite the IC condition as the follows

Xn�t

i¼0

11þ r

� �i

>pcð~qðe� 0ÞÞpðqðe ¼ e�ÞÞ ð8Þ

! 1þ 1r

� �1� 1

1þ r

� �n�t" #

>pcð~qÞpðqÞ

! 1þ 1r

1� 11þ r

� �n�t" #

>pð~qÞ~qð0Þ � m1~qð0Þ

pðqÞqðe�Þ � m1qðe�Þ � cðe�Þ

Proposition 2. The conditions that will lead to a likelihood of early determination of concession contracts are: (1) the greatermarket interest rate r; (2) the shorter the concession periods left n � t; and (3) the greater different of one-time gain from cheatingpcð~qÞ � pðqÞ.

4.3. Discussion and implications

First, a fixed lump-sum concession fee, F, is less efficient to combat a TO’s moral hazard. A fixed concession fee is a sunkcost, which is irrelevant to the quantity a TO produces over the entire concession period. As long as the unit price charged bya TO is greater than the variable cost, pð~qÞ > m1, a TO will keep operating in the short run. Thus, a fixed concession fee alone is

168 G.W.Y. Wang, A.A. Pallis / Transportation Research Part E 67 (2014) 162–174

insufficient to provide incentive to encourage a TO to act in the PA’s interest. It is vital to have a well-designed incentivescheme regarding the pricing of concession fees rather than a fixed lump sum payment.

Mismatched incentives could negatively impact the effectiveness of the concession contract and prevent contracting par-ties to perform their normal functions. We incorporate the unique feature such as performance-based concession fee in agame theory application to emphasize the importance of the incentive compatibility constraint in aligning terminal opera-tor’s objectives to what is desirable for the port authority. By doing so, the concession contract will avoid bias risk-sharingrooted from a fixed lump sum payment.

The problem could also come from the effective monitoring from the PA. The concession agreement provides PAs fullinsurance of risk sharing. If the PA is fully protected against any possible operating risks and collects the concession feesupfront, it has no incentive to examine whether the TO has fulfilled its obligations. Without monitoring on a regular basis,it is more likely for a TO to pursue its own interests.

Another issue is the timing of cheating. Literature has examined the optimal duration of a concession contract in balanc-ing the payback period for the investment and the maximum entry of newcomers from the standpoint of a PA (Notteboom,2007). In the situation with asymmetric information, we emphasize the timing for a TO to deviate from what it is supposedto do after the contract is signed. Ceteris paribus, when t ? n, the left hand side of the I.C. becomes smaller, it is less likely forthe I.C. to hold. Towards the end of concession agreement, a TO is more likely to cheat and make no effort to ensure that goodquality of services is offered. That would be detrimental for the coming operator, in most cases the PA, to fix what has beendone in a relatively long concession period.

Given the concerns discussed above, an important question is what type of mechanism sought after by the PA can be builtinto contracts. As early as Myerson (1979), literature of economic theory provided an example of incentive compatibility(I.C.) constraint to deal with the bargaining problem. The key is to provide incentives to the party with more informationto behave truthfully rather than taking undesirable action in an attempt to benefit their own good. Hence, three possiblesolutions are provided to enhance the I.C. constraint in this study. First, to avoid interest rate risk that leads to the varyingof expected payoff for a TO, a PA may introduce clauses related to the payment with a portfolio of risk hedging financialinstruments. Second, early-bird negotiation of the contract, which provides the incumbent TO an exclusive option to renewthe contract among other interesting parties, ensures the continuing effort by the TO in terminal operation and managementis made. Third, an accelerated profit-sharing mechanism, giving revenue that exceeds normal economic profit back to the TO,can be applied. If the awarding rate increases at an increasing rate over the duration of the contract, then the longer the TOperforms well, the greater the share of rewards it receives.

4.4. Performance-based concession fees

In addition to the mechanism mentioned above, a performance-based concession fee can be applied. Suppose the conces-sion fees are split equally over the entire concession period and are realized after a TO’s performance is evaluated. Thegreater the throughput volumes handled by the TO in period t, the lower concession fee will be charged by a PA in periodt + 1. A quantity-sensitive or a risk-sensitive premium in a dynamic game is proposed. The deduction of the concession feesserves as the implicit subsidy to a TO’s unobservable efforts.

In a sequential-moving game that each player’s payoff functions are common knowledge with complete information, therepresentative TOs and PAs previous moves are observed before the next move is chosen. Suppose the concession feescharged each period decrease at an increasing rate based on the quantity provided in the previous period, whereF 0tþ1ðqtÞ < 0 and F 00tþ1ðqtÞ > 0. The concession fee reduces at an increasing rate. T1 is the concession fees for the initial period.The I.C. condition can be rewritten as

pðp; e�Þð1þ rÞt�1 þ � � � þ

pðp; e�Þð1þ rÞn�1 >

pcðp; eÞð1þ rÞt�1 �

Ftþ1ð~qÞð1þ rÞt

� � � � Fnð~qÞð1þ rÞn�1 ð9Þ

) ðpc½~qðeÞ� � pðe�ÞÞ <Xn�t

i¼1

11þ r

� �pþ Fð~qÞ½ �

If cheating, the opportunity cost of a TO is not only the future profit it could have earned, but also the deduction of con-cession fees over the next n - t periods. If the one-time gain, pc � p, is less than the opportunity cost this TO has to give up,then the profit-maximizing effort level will be chosen by the TO.

4.5. Other key factors determining output and pricing behavior

In the model, we simplify the description of a port authority’s objective and terminal operators’ behavior to emphasizepotential conflict of interest. While mathematical models are simplifications of reality, the key factors determining outputand pricing behavior, complex objectives, and cost structures – for example revenue from ships calling at terminal conces-sions, synergies with other business interests, or defense of passenger throughput guarantee – should be acknowledged inthe text.

G.W.Y. Wang, A.A. Pallis / Transportation Research Part E 67 (2014) 162–174 169

To link the theoretical economics to the evidence of the concession cases of EU and US, two important decision variablesthat influence the objective functions of game players are elaborated. It provides building blocks to qualitatively studyrelated key parameters that influence the feasibility of a concession contract.

Based on the Maritime Administration (MARAD) Port Economic Impact Kit, port initial investment for construction andexpansion can be categorized as follows:

� Property acquisition and site purchase.� Bulkheads, dockside and berths work.� Site preparation including fill, paving, and demolition.� Equipment purchase including cranes and yard equipment, inland and gate equipment telecommunications and com-

puter equipment, lighting and electrical equipment.� Structures including sheds and warehouse, administration building, and passenger terminals.� On-dock and near-dock rail terminals including on-dock intermodal yards, rail track within port facilities, and rail within

the region directly needed for the movement of waterborne cargo.� Dredging including channel deepening and maintenance dredging.� Services including port agency overhead, engineering, architectural, contingency and legal services.

In practice, sometimes terminal operators are responsible for port investment in exchanging the exclusive right of using aport facility. Sometimes port authority bears the initial investment in order to attract terminal operators to commit to a long-term concession contract. A successful concession agreement has to consider both the term of concession period and the rateof utilizing a port facility given the initial investment. Potential acquisition, preparation, and purchasing can be itemized toquantify the scale of investment that influences the setting of the optimal concession contract.

Costs related to efficient operation of a passenger-based port specifically regarding a cruise terminal concession are listedbelow (MARAD Port Economic Impact Kit). Fees and service charges are critical elements in determining a successful con-cession when a liner company enters into a contract with the port authority.

� Services including tugs, pilots, line handling, launch, radio/radar, surveyors, dockage, tenders, etc.� Loading and discharging including stevedoring, clerking and checking, watching and security, cleaning and fitting, equip-

ment rental, agency fee, etc.� Inland transportation including private auto, transit, air, taxi, bicycle and walking.� Government requirement including customs, entrance and clearance, immigration, quarantine, fumigation, etc.� Suppliers and services including chandler, laundry, medical, waste, provisions, and entertainment, etc.� Bunkers including oil, water, and other.� Spending per person per night in port city.

Numbers of ship calls per year, passengers per ship call, and passenger transportation to the vessel determine the headtax, federal cruise tax, and other federal taxes per ship call. Along with the above costs and fees, the public sector sometimescollects royalty charge when the private sector receives excessive profit and stop/renegotiate royalty when the private sectorexperiences financial difficulty. Those details are needed in negotiating the concession and/or operating contracts betweenthe port authority and the concessionaires.

The latest developments of the Port of Galveston with cruise companies are examples of incentives in the operating and/or concession contract.

Royal Caribbean already operates Navigator of the Seas year-round from the Port of Galveston, but the agreement adds an addi-tional 30 calls in both 2014 and 2015, with a year-round vessel in both years. As part of the agreement, the port will invest about$10 million to expand its Cruise Terminal No. 2. Plans include adding about 60,000 square feet to the terminal, bringing it to150,000 square feet with a seating capacity of about 1,000

[(Pulsinelli, 2014, January 28, Houston Business Journal).]

Wharves, a local government corporation formed under the Texas Transportation Code, will construct at its sole cost threeturning basins and, if required by the Galveston-Texas City Pilots, related navigational aids sufficient to accommodate a CarnivalCruise Lines Dream Class Vessel, the ‘‘Carnival Magic,. . . no later than August 31, 2011. . . . Wharves will construct at its sole costthe improvements at or adjacent to Terminal No. 1. . . no later than August 31, 2011. . . .Operator shall deploy a Dream ClassVessel for Year Round Operations from the Berth as a replacement for the Vessel Carnival Conquest. ‘‘Year Round Operations’’ means the origination of a Vessel from the Berth for Cruise Operations no less than 50 times per Operating Year perVessel (for Vessels sailing on a 7 day itinerary) or 75 times per Operating Year per Vessel (for Vessels sailing on 4 and 5 dayitineraries)

[(December 1, 2010, Economic Development Agreement).]

170 G.W.Y. Wang, A.A. Pallis / Transportation Research Part E 67 (2014) 162–174

5. Do incentive approaches exist in practice?

To what extent does the design of concessions in Europe and US, include provisions for the use of concessions fees in linewith the detailed model, as incentives that align the interests of the principal and the agent, and thus eliminate the potentialof moral hazard problems?

5.1. Evidence from Europe

Notteboom et al. (2012) analyzed the ESPO/ITMMA Survey Fact Findings (2008) that included 43 European port conces-sions. This extensive sample of contracts covers various different terminal sectors (61% container terminals, 12% generalcargo, 7% dry bulk and general cargo, 7% dry bulk, and 5% ferry/cruise terminals) and different types of terminal awardingmodels Build, Operate, and Transfer (BOT) projects where the TOs invest in port facilities and will transfer the existing ornew facilities back to the PA when the concession period is terminated; Brownfield projects related to long-term leases ofexisting facility). The findings concluded that the common features in these contracts include the following:

� Financial strength of the concessionaire.� Relevant experience in terms of the expected throughputs.� Duration of the contract.� Performance-based incentives.� Clauses related to the payment of a penalty.

While the specified duration aims to balance the payback period of investment (via longer duration) and the need forentry barriers for newcomers (via shorter duration), the most commonly used performance-based incentives for the TO inorder to meet the objectives of the PA relate to minimum throughput, environmental clauses, and renewal and extensionclauses. The expected throughput stands as the most important criterion in the selection process in about half of the terminalprojects considered.

Based on the ESPO/ITMMA survey published in 2011, in 30% of terminal projects the price bid was not part of the award-ing process due to the specificities of the pricing system used by the PA (Notteboom et al., 2012). Major determinants of theawarding process in a competitive bidding include the expected throughput (the most important indicator), annual conces-sion fees that influence the PA’s revenue flows, contract duration that determines the frequency of call for tenders and pos-sible payback period of investment, and clauses related to performance and the payment of a penalty. Compared to the pricebid reflecting cost-based or fair return pricing, throughput quantity is the most important indicator in awarding of seaportterminals to private sector.

In the case of the biggest, and perhaps the most lucrative, seaport expansion in Europe, the awarding of the two MasvlakteII terminals in Rotterdam in 2009, the PA included a number of provisions referring to the total financial value (NPV) of thebid, the strategy and marketing (competitiveness and positioning in market, expected volumes, projected market position,strategy, extend of market control), sustainability (environment, use of hinterland modes, security) and technical issues (i.e.accuracy terminal capacity, quality of terminal handling concept, flexibility of terminal design.) While the balanced presenceof these criteria was enough to make it a ‘new’ granting terminals approach (De Langen et al., 2012), there was no pricingincentive mechanism.

The rules did not differ insofar as the presence of such incentives, or the concession for operating terminals in SouthernEurope at the Barcelona Muelle Prat Wharf container terminal in Spain, or the Port of Piraeus Container Terminal. In the caseof Piraeus, the concession of the existing container terminal (Pier II) and the rights to develop a new terminal (Pier III), weresubject to the financial strength, experience, technical capabilities to expand capacity, and progressively match increasingthroughput guarantee. The fee was a small lump sum and an annual fee per TEU, adjusted for inflation. Notably, neitherthe two initial agreements (2008), nor the amendment of the concession of the Piraeus project as concluded between thePA and the TO in 2012 included any incentive mechanisms in order to go beyond the guaranteed throughput.

In general, the emphasis of awarding practices in Europe is on annual guaranteed considerations and the minimum pay-ment obligations of the TO, commonly a fee/TEU handled (or fee/tonne) on the basis of the guaranteed capacity. Price capsare not common, whereas lump-sum concession fees at the beginning of the concession are more likely to be observed. Yet,the latter is less a front-loading of the payment and more an insignificant part of the overall payment. All of these practicesdo not provide a pricing mechanism acting as the incentive for the TO to reduce the potential of rent-seeking.

5.2. Evidence from US

Compared to Europe, research and factual information on US seaport concessions are surprisingly limited. Overall, theoperating philosophies of public seaport agencies in the US are dictated largely by local circumstances. Port tariffs are filedwith the Federal Maritime Commission to ensure compliance with the law, and lease and service agreements must be madeavailable to the agency and the public upon request. However, port investment and management decisions are a local, stateor private sector function (for details: the website of the Association of American Port Authorities: AAPA, 2013).

G.W.Y. Wang, A.A. Pallis / Transportation Research Part E 67 (2014) 162–174 171

Leases of operating existing facilities that progressively transformed to concession agreements prepared by public agen-cies have the same attributes as a lease, but carry with those leases not only contribute to business in a way with the min-imum annual TEU volume guarantees, but also ensures the concessionaire’s commitment to invest in facilities andequipment which can be used for an extended period of time. While the two terms today are interchangeable, varianceremains remarkable. Table 1 provides some evidence on the ways that PAs and TOs interests are linked, while it is worthdiscussing the way that these cases confirm or not the conclusions of the founded model.

In 2009, the Port of Oakland entered into a concession agreement with two major carrier customers to extend the existingfacility. Considerable volume was included in the 50-year lease without renewal with Ports America and a contingent optionto expand the premises to include the adjacent berths if the current tenant does not exercise their option. Port remunerationincludes a substantial ($60 million) upfront fee and an annual rent of $19.5 million, subject to inflation increases. After10 years, the TO is required to pay a $15 per TEU fee if the volume exceeds 1.66 million TEUs per year. Current volume isonly estimated at 175,000 TEU, limiting the potential of aggressive seeking of positive externalities (i.e. via trade growth)by the TO.

Ambiguous projects focusing on guaranteed returns alone are not always successful. Such a case is that of the La Quintatrade gateway at Corpus Christi. In 2005, the Port entered into an exclusive short-term agreement with the Spanish companyDragados in order to develop a financial structure and to evaluate the possibility of a long-term concession agreement inoperating the terminal. In a combined effort of a Greenfield concession between the Port and its private developer, the for-mer committed to invest approximately $83 million dollars in the extension of the Channel, Phase One and Two wharfs, androad access and utilities from the highway to the terminal site. Once they completed the construction of Phase One and Two,the terminal would be subleased to the TO for a lease no less than 50 years, responsibility for necessary equipment to operatethe terminal, and exclusive right to implement Phase Three wharf. However, negotiations with Dragados were unsuccessfuland ended in 2008 due to unpredictable changes in market conditions and disagreement on financial terms (Port of CorpusChristi, website).

A different kind of project, the Port of Everett decided to transform the Port Gardner Wharf industrial site into a newwaterfront neighborhood. It provides a case of moral hazard problem due to the absence of incentives. The principal decidedto enhance the economic potential and grant shoreline access for the public to the largest public marina on the West Coast.While the PA concurrently built infrastructure to support private developers, the project has been through extensive plan-ning since 1999. In 2007, it secured all permits and the access of financing through Merrill Lynch and General Electric. How-ever, the global financial crises and the recession in the US caused the project to be placed on hold. The private developer,Everett Maritime, filed for bankruptcy in 2010, the PA terminated the development agreement in 2011, and a Chicago federalcourt judge dismissed a final claim in the Everett Maritime bankruptcy and lifted the development restrictions on the site(Heller and Skinner (2008) and Port of Everett, website). In this case, the profit-driven private developer had exclusive rightsto purchase or lease land within the development site. This was to maximize its own profit since a considerable risk was

Table 1Examples of concession agreements in USA. Source: Authors; Johns (2010), Brogan and Carney (2008), Heller and Skinner (2008), PAs websites.

Year Principal (PA) Agent (TO) Type Period (years) Emphasis/provisions of the contract

2004 Port Everglades MSC Container terminal Operation 10 Minimum annual TEU volume guarantees2008 Port of Miami Maersk & CMA CGM Container terminal Operation 15 Minimum annual TEU volume guarantees2009 Port of Oakland Ports America Container terminal Operation 50 Extension option

Substantial ($60 million) upfront fee and anannual rent of $19.5 million, subject toinflation

2005 Jaxport Mitsui OSK Line Greenfield container terminal 30 Committed to its own container business toinsure the facility has throughput andgenerates revenue from its start

2005 Jaxport Hanjin Shipping Greenfield container terminal 30 Committed to its own container business toinsure the facility has throughput andgenerates revenue from its start

2005 Corpus Christi PortAuthority

Dragados-Services of Portand Logistics (Dragados)

Greenfield container terminal 50 (at least)Cancelled

Substantial investment ($83 million) of PA

Exclusive option for expansion andsubleasing

2007 Port of Everett Everett Maritime Port Gardner Wharf project,(Largest marina on the WestCoast)

Cancelled Exclusive rights to purchase or lease landwithin the development site

2002 Port of Galveston Royal CaribbeanInternational, CarnivalCruise Lines, andCH2MHILL

Design-Build Greenfield project(cruise terminal)

10 Innovative financial scheme

Minimum annual passage guaranteesFee waiver and revenue rebate

172 G.W.Y. Wang, A.A. Pallis / Transportation Research Part E 67 (2014) 162–174

involved. The PA could receive leasing revenue and other implicit economic profit such as potential taxes revenue, job oppor-tunities, and public benefits of the recreational area for the citizens. The PA, however, had little to do with supervising, mon-itoring, or controlling the private developer to ensure project goals were achieved on time. There was a conflict of interestand a lack of incentives between the principal and the agent. Without a proper incentive scheme and/or subsidy, the positiveexternality such as local commercial development and improvement of the quality of life of citizens may not result.

The Galveston cruise terminal project provides evidence on how the financial structures of the concession might act asincentives to match the preferences of the PA and TO in the long run. Like the previous ones, this project was also expectedto stimulate local and state economic development, increase tax base, and create job opportunity. However, a different typeof agreement is involved as regards to the distribution of the operating risk and which partner is responsible to initial infra-structure investment. In this first Design-Build Greenfield project in Texas ports (National Council for Public-PrivatePartnership (NCPPP), 2004), the PA which is responsible for planning and operating the port entered into a three phase agree-ment with Royal Caribbean International, Carnival Cruise Lines, and CH2MHILL to expand cruise ship service and redevelopthe existing terminal facilities. Phase One included the transformation of an existing old warehouse to a passenger terminal,renovation of wharf facilities and construction of access/circulation roads for embarking and disembarking passengers. PhaseTwo was to demolish the headhouse to make space for the port’s expansion and Phase Three focused on the expansion of theexisting Terminal and the upgrade of interior facilities to increase the terminal utilization and efficiency (Port of Galveston,2010).

The project was done in a cost-saving and timely manner due to two financial innovations. First, the cruise line contractsof Royal Caribbean and Carnival Cruise Lines and the lease with the port were handled by an independent legal entity. The PAcould utilize and allocate operating profits from that entity for future infrastructure expansion. As stated by the NCPPP, ‘‘thepublic sector conserved its capital funds, while receiving increased revenues from growth in related employment and commercialrevenues, and strengthening its ties with the business community’’ (2004). Without the third-party entity to align the interestsand objective of the port to its private developers, costly renegotiations of contract may result. Second, construction wasfinanced by a fixed-price bridge loan until the port could place a bond, a financial structure that is unique to the cruise indus-try. The private sectors are willing to provide upfront payment in exchange for exclusive earnings on investment.

In 2010, a separate utility of the City of Galveston (Galveston Wharves), a Texas nonprofit corporation (Galveston PortFacilities Corporation), and Carnival Corporation (Operator) entered into a lease of Economic Development Agreement inorder to facilitate the improvements to Terminal 1. The operator provides funds to pay for construction and developmentcosts, and will be repaid in revenues from line handling dockage, passage wharfage, and parking revenues rebate(Mierzwa, 2012). Wharves will construct at its sole cost the improvement at or adjacent to the terminal. In addition, incen-tives provided by the PA to enhance long-term partnership included 12.5% of the parking revenues that exceeded the thresh-old to be paid to the operator if one of the replacement vessels is performing. The operator will receive 25% of the parkingrevenues and dockage fee waiver when two vessels are in port. In exchange for the initial investments and right to use theconstructed facilities, the operator committed to a 10 + 2 year agreement, a year-round operation using no less than twovessels of a particular class no less than 50 times per operating year, and the payment of a guaranteed minimum annual pas-senger wharfage.

6. Conclusions

This paper provides a game theory foundation for port concession agreements, using the incentive mechanism design.Privatization in ports is more about transferring public port services and outsourcing certain functions to the private sectorvia concession agreements, rather than moving asset ownership. In such agreements, the involved parties’ (PAs and TOs)incentives are not aligned automatically when asymmetric information exists. The analysis establishes a model that canguide contracting parties to a fair contract incorporating both public and private interests and resulting in mutually bene-ficial outcomes.

Compared to the pre-bidding and awarding procedure of a concession, we study issues in the selection and post-biddingphases. When maximizing a set of objectives representing port authority and terminal concessionaires, we demonstrate themoral hazard problem that occurs when the interests of the contracting parties are not automatically aligned. Throughputguarantee is the most common practice in awarding seaport concession. On the other hand, a threshold with flexible feestructure is not commonly observed. In order to avoid costly comprehensive monitoring, performance incentives includinghigh lump sum concession fees and/or terminal performance targets can be used for granting agencies to aligned incentivesbetween contracting parties. With high concession fees, port authority shifts operating risks to the concessionaires. But thenegative externality, such as insufficient throughput volumes and inefficient land productivity, could detriment the devel-opment of local economy after the contract is ended. In regards to terminal performance target, the port authority has torevisit the contract constantly. Concerning minimum monitoring effort, there are bonuses and penalties applied if the con-cessionaire performs above or below the target measures.

After comparing the implications of the model in Section 4 with the design of several port projects in Europe and US, itwas discovered that practice contradicts economic theory, as there are rarely incentives included in the design of these con-cessions although that would be beneficial to avoid the moral hazard. In the cases detailed, container terminals, cruise ter-minals (where the mechanism differs remarkable and is more a typical PPP agreement, and the financing scheme contains

G.W.Y. Wang, A.A. Pallis / Transportation Research Part E 67 (2014) 162–174 173

unique elements) or waterfront development, the emphasis was more on guarantees for minimum level activities (financialor operational/trade ones). In Europe, price caps are not common, whereas lump-sum concession fees in the beginning of theconcession are more likely to be observed. Compared to European ports, similar results can be found when the scope of anal-ysis extends to US cruise terminal concessions (where the best practice was discovered) and waterfront developmentprojects.

Evidently, to avoid transaction failures in a Greenfield concession, the PA needs to identify clearly the objectives and thetransactions undertaken. The port should have the ability to enforce the contract and determine the process of quality assur-ance. It is particularly crucial when the PA has high upfront proceeds and less-to-none ongoing benefit but vice versa to theconcessionaire. Likewise, it proved to be dangerous if the concessionaire has high upfront proceeds and no ongoing revenuethroughout the entire concession period. Either case will create an opportunity for the advantageous party to deviate fromthe contractual agreement.

The challenge for port managers and policy-makers is to match theory and practice. In theory, a successful concessionproject is determined interdependently by the types of private sector involvement, structure of concession agreements,length of the duration, and overall economic and finance environment. Factors relevant to a successful contract includethe scope of concession agreement, structure of flat or variable concession fees, availability of quality assurance and quantitythroughput guarantee, public sector intervention and monitoring, market structure and competitiveness of TOs, and stick-iness of market response of port users. In the model, under the circumstance with asymmetric information and uncertainty,performance-based concession fees are effective to overcome the moral hazard problem after the contract has been signed.

The model implies that if the PA has little to do with supervising, monitoring, or controlling the private developer, thepositive externality, such as local commercial development and improvement of the quality of life of citizens, may not berealized. Not only huge monetary losses may occur through renegotiation of contracts and early termination, the prolongeddelay of port development also impacts the competitiveness of the ports and their local economies. To avoid failures of ter-minal awarding transaction in a Greenfield concession, the PAs need to clearly identify the objectives and the transactionsundertaken. The port should also have the ability to enforce the contract and determine the process of quality assurance.

The detailed economic framework based on the incentive theory provides also a foundation for future port research. Withfinancial data and operating status being used toward revising the objectives of and incentives mechanism between the PAand TOs, a future research agenda might include: 1) revising the principal-agent model using available contract agreementsand numerical data provided by the PA; 2) working on build-in sensitivity analysis that considers the shock of constantlychanging global economics and shipping/business cycles; 3) extending the study scale to various types of concession agree-ments and comparing the fair and appropriate incentive mechanism for different types of contracts; and 4) building furtherthe (currently missing in port studies) ports case study database that can be used for future empirical studies.

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