Deadline-based incentive contracts in project management with cost salience

Abstract

The contractor’s procrastinating behavior owing to the psychology of cost salience exposes the project manager to the risk of time delay, which brings a significant challenge in project manager’s incentive contract design. This paper considers that a project manager pays a contractor over a menu of deadline-based incentive contracts to conduct a project which consists of two sequential tasks. The contractor is endowed with private cost salience information and unobservable efforts. The subjective assessments about the cost salience degree and the project variability are characterized as uncertain variables. Within the framework of uncertainty theory and principal-agent theory, we investigate the impacts of the existence of cost salience and information asymmetry on the incentive contract and the project manager’s profit. We confirm that cost salience can impel the project manager to lower both the fixed payment under full information and the penalty/incentive rate under pure moral hazard. Interestingly, we find that moral hazard can weaken the extent of inverse impact caused by the existence of cost salience for the project manager. Our study also shows that, for mitigating the adverse impacts brought by moral hazard, the project manager is more profitable to provide effort incentive when the contractor’s efforts are more productive or the project risk is in a higher level. Finally, other suggestions for mitigating the detrimental impacts brought by adverse selection are provided by numerical experiments.