Analysis of Adverse Selection for Motivation Mechanism in Engineering Project Cost Management

Abstract

When the principal-agent contracts for design, supervision and construction of an engineering project are signed, the agent and the principal have hidden information. By means of tendering and negotiation, etc., it selects an agent offering a lower quotation which leads to "Bad money drives out good", that is, commonly termed adverse selection problem. This study starts from the discussion of adverse selection and introduces a motivation mechanism to motivate the agent to exert initiative strategies more efficiently so that the agent can expose its hidden information automatically. The study also analyzes the project principal-agent strategies and finally uses a calculation example to demonstrate that the motivation mechanism in this study is efficient in inducing the agent to tell the truth, which aids the principal in selecting an agent with higher operational level.

Risks Caused by Information Asymmetry in Construction Projects: A Systematic Literature Review

“…It is also used to explore the impact of other incentive mechanisms, such as cooperation and reputation [66,67]. Furthermore, simulation is used to explore the behavior of agents in a pre-contract [68,69] or post-contract process [29,32,[70][71][72]. Finally, the authors use simulation to investigate the impact of different mitigation strategies on the probability of opportunistic behavior between participants [73,74].…”

“…These measures include a definition of incentives for agents. For example, agents are incentivized to honestly report their expenses [68,128] and other important information [96] to finish the work as planned [10,29,30,34,45,46,56,58,60,62,67,70,71,73,79,81,82,88,108], to recover after unforeseen events [56] and to adapt to different project circumstances [61,63,95]. The contract should also include the following: objective criteria for its enforceability [48,49,90], clear intentions of both parties [10,79,82,108], fair risk-sharing [32,86,91,96,101], mechanisms for cost adjustment according to the market situation [59], quality standards, technical specifications and performance specifications [43] and protective measures (guarantees), such as, for example, minimum rates of return, minimum income and maximum cost limits [102].…”