Incentive Contracts in Serial Stochastic Projects

Tony Chen (), Ted Klastorin () and Michael R. Wagner ()
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Tony Chen: Department of Information Systems and Operations Management, Michael G. Foster School of Business, University of Washington, Seattle, Washington 98195
Ted Klastorin: Department of Information Systems and Operations Management, Michael G. Foster School of Business, University of Washington, Seattle, Washington 98195
Michael R. Wagner: Department of Information Systems and Operations Management, Michael G. Foster School of Business, University of Washington, Seattle, Washington 98195

Manufacturing & Service Operations Management, 2015, vol. 17, issue 3, 290-301

Abstract: In this paper we propose an incentive payment contract for stochastic projects defined by a series of stages or tasks that are outsourced to independent subcontractors. Projects defined by sequentially completed independent stages are common in new product development and other high-risk projects. Our goal is to maximize the client’s expected discounted profit. Our proposed contract reflects the convex time-cost trade-off that is well known in the project scheduling literature. We show that this type of contract dominates a fixed price contract with respect to expected client’s profit and schedule performance, regardless of payment timing considerations. Using a piecewise linear approximation, we show that our contract is a generalization of an incentive/disincentive contract that is frequently used in practice. We show how our contract can be used to find the optimal due date and penalties/bonuses in an incentive/disincentive contract. We compare this contract with several variations and discuss implications for both the client and subcontractors.

Keywords: incentives and contracting; production planning and scheduling; product development and design (search for similar items in EconPapers)
Date: 2015
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Citations: View citations in EconPapers (14)

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Persistent link: https://EconPapers.repec.org/RePEc:inm:ormsom:v:17:y:2015:i:3:p:290-301

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