Risk allocation and double moral hazard in construction contract

Abstract

In this paper, the contract schemes for construction projects in the developing countries are formulated in the form of an incomplete contract model, whereby the double moral hazard issues driven by the owners as well as contractors are investigated. The effort levels of the owners and the contractors are supposed to be unverifiable and mutually complementary with respect to costs risk reduction. It is shown that the moral hazard by the owner, who transfers the excessive cost overrun caused by the owner's indulgence to the contractor, may trigger the moral hazard by the contractor; thus, the moral hazard issues by the owner may lead to the overall inefficiency of the project. In this paper, the optimal risk allocation scheme between the owner in the developing countries and the contractor, which can deter the double moral hazard issues and enhance the project efficiency, is theoretically investigated.