Opportunism, either governmental or private, may become a powerful deterrent against public-private project financing, especially considering the scale of the investment in infrastructure. The parties can, however, secure themselves against the counter-party’s possible opportunism by assigning the investor an exit (put) option and the public agent a bail-out (call) option on the private investor’s shares. This paper presents a mechanism for converting natural monopolies into contestable markets using over-the-counter option contracts that combine the stability of long-term contracts and the flexibility of short-term contracts. The exit/bail-out option mechanism reduces entry barriers by streamlining incomplete long-term contracts and avoiding contractual problems related to bounded rationality and opportunism. Incorporating exit/bail-out options to public-private contracts with sunk investments increases the set of payoffs for each discount factor comparing not only to one-shot games, but also repeated games without options, and —most importantly— facilitates cooperation.
