Menassa, C C; Mora, F P and Pearson, N (2009) Option pricing model to analyze cost-benefit trade-offs of adr investments in AEC projects. Journal of Construction Engineering and Management, 135(3), pp. 156-168. ISSN 0733-9364
Abstract
Alternative dispute resolution (ADR) techniques are adopted by architecture, engineering, and construction project participants to help achieve reasonable settlement of claims and change orders (CCOs) that arise during a project's life cycle without having to resort to protracted litigation for final determination of merit. Since such ADR techniques require resources to prepare, review, and resolve CCOs, the managerial decisions regarding the investments for these resources need to be economically justified. The application of the net present value approach to determine the value of any ADR investment is limited because the future cash flows resulting from such an investment cannot be estimated a priori as they will vary with the nature of the CCOs, the amounts claimed, and the effectiveness of the ADR in addressing these CCOs. This paper presents a conceptual and mathematical model to evaluate ADR investments by drawing an analogy from theories of financial and real option pricing. The objective is to provide the owner with a decision framework that accounts for the uncertainty in estimating the ADR investment cash flows during the project planning phase, and provides realistic results regarding the value of this investment. The model presented in this paper is applied to a real case study involving a seismic retrofit of a bridge project to demonstrate the parameter estimation and the practical application of the model.
| Item Type: | Article |
|---|---|
| Uncontrolled Keywords: | benefit cost ratios; claims; construction costs; costs; dispute resolution; mathematical models |
| Index terms: | construction project, estimating, project planning, alternative dispute resolution, parameter-estimation, mathematical model, cash flow, drawing, effectiveness, option, resolution, real option, bridge project, pricing, case study, net present value, change order, litigation, dispute, construction cost, owner, life cycle, decision framework |
| Subjects: | economic analysis, financial and cost management, technical documentation, control systems, value management, dispute resolution, data collection methods, mathematical modelling, infrastructure and transport systems, statistical analysis, conflict resolution, sociology, decision analysis, contractual condition, production management, contract management, financial management, performance management |
| Topics: | Contract Administration, Quality Management, Design Practice, Legal Issues, Stakeholder Management, Risk Management, Project Management, Research Practice, Engineering Principles, Cost Management, Business Strategy |
| Descriptive scope: | 5 PCTEA |
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