Contract

Contact Options –

The success of projects depend a lot of effectiveness. There is a tremendous amount of difficulty in writing complete, enforceable contact in the real world. Monitoring of contracts and providing incentives can help but not eliminate the problem of one party taking advantage at another party’s expense.

Example: Owner – Contractor Relationship

Construction contracts have two basic types:

Cost Reimbursement (cost plus contacts) – the owner pays a fee or a percentage above the actual cost of the work performed. Cost reimbursement contracts provide an advantage to the contractor is the work is more costly or takes longer to complete.

Fixed – Based on a rough estimate to complete the work. In a fixed contract the contractor has no incentive to either increase or decrease costs. In order for the contractor to be more profitable the contractor may decrease the workforce, higher unskilled labor or decrease quality of the work.

How this works:

This type of option provides the owner with an advantage in all circumstances. If input prices increase, the owner will exercise the option and the contractor bears the cost increase (choose the fixed contract). If prices fall, the owner does not exercise the option and the cost plus contract applies.

References:
http://www.entrepreneur.com/tradejournals/article/169383068_2.html
http://www.realoptions.org/papers2004/Boukendour.PDF

Prepared by: Tyler Henderson
The presentation is in the attached file…Ken

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