Contractual Incentives

Abstract

Contract incentives are the means by which an owner intends to secure certain project goals through the contracting process. Incentive contracting is designed primarily to reduce cost in negotiated contracts through profit sharing ratios, which should improve on the efficiency of cost reimbursable contracts. In the process, financial risk and control are shared by the owner and contractor, according to a ratio which is established in the early stages of project design. Contractual incentives are used frequently in construction to reduce overall project time. However, there is a lack of published research on the theory and consequences of the use of incentives in construction. Studies in government research and development contracts using incentives shows that contractors may not always behave in the fashion intended by owners designing such contracts. The apparent reason is that the risk a contractor assumes under conditions of limited scope and design information biases the setting of targets, so that overruns/underruns are more dependent on where targets are set, rather than on sharing ratios. In the construction industry this is apparently recognized, and targets are not fixed until design is approximately 40%–60% complete. Moreover, as the contractor and owner attain more knowledge of the project, both parties should attempt to reduce owner risk and control.