Contract Strategies for Major Projects

CHAPTER 8The Use of Supplemental Incentives

All contracts contain an incentive structure for contractors. When we discuss “incentives” in contracting, we usually mean incentives that supplement and usually attempt to modify or augment the incentive structure that comes with the contractual form. For example, every EPC‐LS contract is the fully cost incentivized contract. Every reimbursable contract carries within its structure the possibility of the contractor making more money through more hours charged whether or not those hours are strictly needed. In other words, every basic contractual form carries some version of the principal‐agent problem. Supplemental incentives seek to ameliorate those problems. I emphasize the supplemental nature of incentive schemes because I find that many practitioners tend to forget the primary incentive structure as they approach incentive contracting. Supplemental incentives usually seek to “swim against the flow” of the contract's primary incentive scheme because it is believed that the primary incentive scheme contains some inherent misalignment of the principal (owner) and the agent (contractor). Often, the primary incentives overwhelm and render moot any of the supplemental incentives we seek to forge. At other times, the supplemental incentive may interact with the primary incentive to create unintended consequences.

For the analysis for this chapter, I have excluded the integrated project delivery/alliancing projects. They are incentivized ...