Optimal outcome sharing arrangements in construction target contracts

Target contracts are commonly used in construction to share the equivalent monetary outcome of work or of a project. However, universal agreement has not been reached, and discussion is ongoing, as to what is the optimal sharing arrangement. Despite an extensive body of publications on target contracts, no guidelines exist in the literature for what the optimal outcome sharing arrangement should be. This thesis addresses this shortfall. It derives optimal outcome sharing arrangements for all the various combinations of the main variables that exist in contractual arrangements and project delivery. Such variables include: the risk attitudes of the parties (risk-neutral, risk-averse), single or multiple outcomes (cost, duration, quality), single or multiple agents (contractors, consultants), and cooperative or non-cooperative behaviour. Optimization, utility, expected utility and related theories provide the underlying basis in this thesis. Practitioners (contractors, design consultants and owners) were interviewed in order to validate the results. The thesis shows that: (i) In non-cooperative contracting with a risk-neutral contractor, at the optimum, and expressed relative to the target, any favourable or adverse outcome associated with both the contractor's effort and events beyond the contractor's influence should respectively be wholly received by or wholly borne by a risk-neutral contractor. (ii) In non-cooperative contracting with a risk-neutral owner, at the optimum, the proportion of outcome sharing to the contractor should reduce and the fixed component of the contractor fee should increase when the contractor becomes more risk-averse, the level of the outcome uncertainty increases, or the effectiveness of the contractor effort decreases. (iii) In non-cooperative contracting with a consortium of contractors, at the optimum, the proportion of outcome sharing among contractors with the same risk-attitude should reflect the levels of their contributions. The proportion of outcome sharing among contractors with the same level of contribution should be lower for contractors with higher levels of risk aversion. A consortium of risk-neutral contractors should receive or bear any favourable or adverse outcome respectively; and the proportion of outcome sharing to a consortium of risk-averse contractors should reduce, and the fixed component of the consortium fee should increase, when the contractors become more risk-averse or the level of the outcome uncertainty increases. (iv) In non-cooperative contracting with multiple outcomes, at the optimum, the proportions of outcomes sharing to the contractor should be higher for outcomes with lower effort cost and a lower level of uncertainty. By increasing the correlation between outcomes, the fixed component of the contractor s fee should increase and the proportions of outcome sharing to the contractor should decrease. (v) In cooperative contracting between an owner and a contractor, at the optimum, the sharing arrangement is linear in the project outcome and is affected by the parties risk aversion. The outcome uncertainty has no influence on the sharing arrangement. (vi) In cooperative contracting with three parties, owner, contractor and design consultant, and within different delivery methods, at the optimum, the proportions of the outcome sharing to the contractor and design consultant are affected by the owner, contractor and design consultant levels of risk aversion. The sharing to the design consultant is independent of the delivery method used and the proportion of the sharing to the contractor changes with delivery method. The thesis proposes original solutions to the problem of establishing optimal sharing arrangements, thereby contributing to current practices in contracts management. The thesis will be of interest to academics and practitioners interested in the design of target contracts and project delivery. It provides an understanding of optimal sharing arrangements within projects broader than is currently available.