Abstract
Effective change order management is very important in maintaining the financial sustainability of various stakeholders related to construction projects by minimizing cost overruns. In this study, we propose a zero-cost risk management approach based on the collar option model in order to control for the loss caused by change orders, the main cause of cost overruns in construction projects. We apply this model to actual projects for empirical analysis. The analysis, based on 237 projects, indicates that insurance buyers benefit from the collar option model in 46% of the cases, while insurance sellers do so in 53% of the cases. In most cases, the insurance buyer is the owner. According to the model, the owner experiences a loss when the cost overrun caused by change orders is lower than what was expected. In such cases, it is appropriate to conclude that the loss is not caused by the collar option model, but by the absence of additional revenue. However, the insurance seller suffers a loss if the cost overrun is higher than the strike price of the call option. Thus, the insurance seller needs to have expertise in construction management.
Highlights
IntroductionChange orders are issued to correct or modify the original design or scope of work
Changes during the construction phase are inevitable in most construction projects
(46%), the cost overrun is higher than the strike price of the call option, which is when the insurance buyer gains a benefit from the collar option model
Summary
Change orders are issued to correct or modify the original design or scope of work. These corrections or modifications are carried out for various reasons, including changes in scope made by the client and changes made as per the consultant’s change requests because of design errors or new findings. Most of the change orders issued during the construction period generally lead to significant time and cost overruns, disruption, and disputes [1]. Change orders significantly affect whether the construction project succeeds or fails. As construction projects are mostly financed through borrowing, the increase in the project cost leads to financial distress of many stakeholders such as the client, the financial institution and the construction company [2]. Financial distress threatens the financial sustainability of these stakeholders [3]
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