Executive Summary
This report provides a starting point for analysing the optimum/preferred contractual arrangements between Technology One and it’s government clients. It is highlighted that the fixed-price contract arrangement exists in order to shift as much risk as possible from the government client (principal) onto the vendor (agent).
In this environment where there is considerable information asymmetry (the principal is managing the agent primarily on outcomes), there is much scope for moral hazard. Warranty clauses, which are designed by the agent to be a signal of commitment, end up becoming an area for moral hazard.
We discuss why government clients become risk averse as a starting basis for understanding Technology One’s preferred contractual arrangements. It is suggested that an incentive-based contract would be more likely to produce an innovative solution for the principal and would more closely align the motivations of the two parties. Alternatively, the use of a performance surety bond may alleviate the risk for the vendor, but only serves to increase the average bid price for the principal.
Technology One are currently considering introducing a performance bonus for project managers. This incentive would be gauged on the project’s profit. However this observable outcome is only one of three outcomes which are required for a successful project. The other two outcomes are firm reputation and repeat business, which are both much more difficult to observe. If Technology One are to introduce an incentive scheme it must try to take into account these other two objectives. However, the introduction of these two unobservable objectives creates an almost intractable sharecropper problem where the project manager will be intrinsically encouraged to s ...