Impacts of uncertain project duration and asymmetric risk sensitivity information in project management

Abstract

AbstractThis paper investigates the impacts of uncertain project duration and asymmetric risk sensitivity information on the structure of incentive contract and profits in project management where a risk‐neutral project manager (she) engages a risk‐averse contractor (he) to complete a project. The project manager offers a duration‐based incentive contract to the contractor to ensure that he invests his effort to shorten the project duration and reports his risk sensitivity information truthfully. Within the framework of principal‐agent theory, we first develop a duration‐based incentive contract model, and then derive the optimal contract mechanism by solving its equivalent optimal control problem with Pontryagin maximum principle. We show that if the contractor is highly risk averse and the project duration is highly volatile, the project manager should lower the penalty term to motivate the contractor to make duration‐reduction efforts. Moreover, comparing with the symmetric information scenario, we find that the project manager distorts the penalty term for all contractor's risk types (but the lowest) downward. Our results show that the project manager is more willing to acquire the contractor's risk sensitivity information under the uncertain project duration. The results also suggest that from the project manager's perspective, it is beneficial to have better information about the contractor's risk sensitivity by using a numerical analysis.