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Optimal contracts for large scale projects with asymetric information
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We consider a repeated contract game between a sponsor and a contractor concerning a large scale project where the project requires a number of tasks to be completed before the benefit from the project can be realized. The contractor has private, cost specific information which is relevant in cost determination. Moreover the contractor supplies effort which affects the cost of completing a task. Thus the sponsor must resolve both moral hazard and adverse selection problems in designing the remuneration scheme offered to the contractor. In chapter 3 we focus on the case where the sponsor can precommit to compensation per task, where the
contractor is not bound to complete the project, and where the contractor knows precisely the cost of each task right from the beginning of construction of the project. In this setting we construct the optimal "direct contract", and show that, for each particular firm, the optimal payment consists of two parts: the true cost of the project plus the contractor's reservation level of profit and a premium term which increases with the maximum number of high cost tasks that the sponsor is willing to allow. In chapter 4 we focus on the case where the sponsor cannot precommit to compensation per task and where the contractor learns about the cost of each task only upon task completion. We demonstrate that, in this case, the equilibrium compensation path rises as the project nears completion giving the appearance of cost overruns towards the tail end of the project. We also consider several extensions of the basic model which amplify on these results.