Strategic choices for railroad expansion: an analysis based on real options

Abstract

This paper aims to analyze the strategic choices concerning the proper governance structures for building and operating logistical infrastructures. In order to illustrate our arguments, we use as an empirical example the alternatives for expanding the rail network in Bahia State, Brazil. The new railroad considered in our exercise is about to connect the Bahia Western region to the Atlantic Ocean. The presence of uncertainty surrounding the investment requires the use of real-options theory. The uncertainty is boosted by the interdependencies betweenpotential investor’s decisions and the choices of the current operator of an existing railroad that might or not be incorporated to the new venture. From the methodological point of view, we built a binomial decision tree upon the deterministic present value of the investment. We also run semi-structured interviews with the public and private actors involved. Such interviews provided us with the understanding of context-relevant aspects. Our analysis show that the interdependencies among actors – current operator of an existing track, potential investors and government – play a leading role in the decisions to be made, once strategic actions may shift supply and demand standards. Last, we discuss some governance structures, which might make viable the studied railroad expansion. We conclude that the government still remains playing a leading role in railroad expansion. In fact, the existing hazards may undermine those investments exclusively performed by private actors.

Key words: railroads, real options, PPP.