Contract management for complex projects - Contract management and contracts: agency theory
6 important questions on Contract management for complex projects - Contract management and contracts: agency theory
Define the Agency Theory. Give the related problems and focus of agency theory.
Agency theory: relationship between the principal (gives assignment to somebody) and agent (like employer- employee & purchaser - supplier)
Agency problems:
- Goal conflict between the principal and agent;
- Difficult to verify what the agent is actually doing
- The principal and agent have different risk preferences.
The focus of agency theory:
- "Determining the most efficient contract governing the principal - agent relationship governing the principal - agent relationship
- Behaviour-oriented contracts (e.g. salary) or outcome oriented contract (e.g. stock option)?
Essentially, the agency problem finds it origin in the risks that parties face when collaborating.
Define contract management and give the underlying three stages.
There are three contract management stages:
1. The pre- contractual stage;
2. The contract negotiations stage;
3. The post - contractual stage.
The three stages are interrelated: problems that have occurred in the pre-contractual stage between contract partners may surface during project execution and delivery. Therefore, it is important to be aware of the full contracting process when engaging in a contract.
What are reasons for not using Performance Based Contracting?
-Buyers have insufficient experience/ are not mature enough to fully utilize PBCs
-Basis for performance measurement and evaluation is not easily defined --> leads to disputes about the results
-PBCs are difficult to implement, because they require a different contract management approach.
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What are difficulties with Performance Based Contracting?
- Performance- based contracting perceived as risky and costly and in desperate need for clearer specifications;
- Thorough agreement on metrics that represent effectiveness and on reward scheme essential;
- Use of output - and outcome- based specifications usually results in more responsibilities (and risk) being shifted to the supplier:
- Supplier may not accept these responsibilities;
- Buying company needs to able to deal with these "remote" responsibilities.
Which risks should be covered by contracts?
Agent opportunism: situation where agent will act primarly out of self- interest --> outcome - based contracts are more effective in curbin;
Moral hazards: risk that both contractual parties will primarly pursue their own interest.
Conflict of interest: buyer wants to pay as little as possible and seller wants to charge as much as possible.
Conflict system: contractual relationship where parties pursue different objectives
How do you identify the content of the service in a contract?
Output: Specifying what you see and know of as desired performance + specifying outcome - often linked to specific forms of contract (risk sharing/ gain sharing, no cure- no pay)
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