Optimal Contract Mechanism Design for Performance Based Contracts

Project summary:

Performance-based contracts (PBCs) have increasingly become the norm for procuring services. In a PBC, the owner and the contractor agree upon a set of short, medium, and long-term performance/quality metrics. The contractor is paid both a lump sum upon completion of tasks and a stream of recurring payments. The schedule of recurring payments is based on the degree of compliance with a set of agreed-upon metrics.

PBCs are widely used by the federal government, in the health care and financial industries, and by buyers in supply contracts. State transportation agencies, however, have been slow to adopt PBCs as a method of procuring construction services.

The goal of this research was to examine the design of PBCs and of specific contract mechanisms that may encourage state transportation agencies to use them in the future. The researchers developed mathematical models to examine the relationships between contract parameters, bid amounts, and allocation of risk, as well as project coordination. The ultimate goal was to determine optimal contract parameters.