Time-Related Incentive Contracts for Managing Projects with Uncertain Completion Time

Abstract

Due to contractor’s unintentional and intentional poor planning, project delays are common. When project delays affect the manager’s payoff negatively, what kind of incentive contracts should the manager offer especially when she does not have perfect information about the amount of work involved or the contractor’s cost structure? In this chapter, we evaluate two commonly used time-related incentive contracts (C1 and C2 contracts) when the manager conducts a reverse auction to select the contractor for a project. Under the C1 contract, the contractor with the lowest bid price wins; however, the manager imposes a linear and symmetric incentive/disincentive for early/late completion. Under the C2 contract, the winning contractor has the lowest composite score that is based on the quoted price and the quoted due date; meanwhile, the contractor is subject to a late completion penalty. Our analysis reveals that, unless the project is truly urgent and the winning contractor can set his work rate after observing actual workload, the more complicated C2 contract adds no value to the manager: the simple C1 contract will suffice.

The revision(s) of this paper were prepared during a sabbatical leave at the Haas Business School of University of California, Berkeley.