Skip to main content
SpringerLink
Log in

Optimal gainshare/painshare in alliance projects

  • Special Issue Paper
  • Published:
Journal of the Operational Research Society

Abstract

Alliances are popularly used in delivering infrastructure. However, discussion is ongoing as to what is the optimal gainshare/painshare arrangement. This paper derives a result for the optimal gainshare/painshare between risk-averse parties, where the level of aversion may range from very large to being risk neutral. The derivation is based on solving an optimization problem using concepts from agency theory. The influence of the parties’ level of risk aversion and outcome uncertainty is examined. Practitioners were engaged in a designed exercise in order to validate the approach and propositions. The paper shows that: (i) the optimal gainshare/painshare arrangement in alliances is linear in the project outcome; (ii) the optimal gain/pain share to the contractor should decrease with increasing contractor level of risk aversion and/or decreasing owner level of risk aversion; and (iii) the outcome uncertainty has no influence on the optimal gainshare/painshare. The paper provides those who write alliance contracts with recommendations on gainshare/painshare. This study casts new light on establishing optimal alliance arrangements in the construction industry.

This is a preview of subscription content, log in via an institution to check access.

Access this article

Log in via an institution

Price excludes VAT (USA)
Tax calculation will be finalised during checkout.

Instant access to the full article PDF.

Institutional subscriptions

Figure 1
Figure 2
Figure 3

References

  • AAA (2010). Alliancing Association of Australasia, General overview, http://www.alliancingassociation.org/Content/Attachment/AAAGeneralPresentationDec2010.pdf, accessed 15 February 2011.

  • Abrahams A and Cullen C (1998). Project alliances in the construction industry. Australian Construction Law Newsletter. Oct/Nov 31–36.

  • Al-Bahar JF and Crandall KC (1990). Systematic risk management approach for construction projects. Journal of Construction Engineering and Management 116 (3): 533–546.

    Article  Google Scholar 

  • Al-Subhi Al-Harbi KM (1998). Sharing fractions in cost-plus-incentive-fee contracts. International Journal of Project Management 16 (2): 73–80.

    Article  Google Scholar 

  • ANAO (2000). Construction of the National Museum of Australia and the Australian Institute of Aboriginal and Torres Strait Islander Studies. Audit Rep. Australian National Audit Office: Canberra, Australia.

  • Anderson E (1985). The salesperson as outside agent or employee: A transaction cost analysis. Marketing Science 4 (3): 234–254.

    Article  Google Scholar 

  • Badenfelt U (2008). The selection of sharing ratios in target cost contracts. Engineering, Construction and Architectural Management 15 (1): 54–65.

    Article  Google Scholar 

  • Bartling B and Von Siemens FA (2010). The intensity of incentives in firms and markets: Moral hazard with envious agents. Labour Economics 17 (3): 598–607.

    Article  Google Scholar 

  • Bergquist W, Betwee J and Meuel D (1995). Building Strategic Relationships. Jossey-Bass: San Francisco.

    Google Scholar 

  • Bolton P and Dewatripont M (2005). Contract Theory. MIT Press: London.

    Google Scholar 

  • Broome J and Perry J (2002). How practitioners set share fractions in target cost contracts. International Journal of Project Management 20 (1): 59–66.

    Article  Google Scholar 

  • Campbell P and Minns D (1996). Alliancing—The East Spar and Wandoo projects. AMPLA Bulletin 15 (4): 202–214.

    Google Scholar 

  • Carmichael DG (2000). Contracts and International Project Management. AA Balkema: Rotterdam.

    Google Scholar 

  • Carmichael DG (2002). Disputes and International Projects. AA Balkema: Rotterdam.

    Google Scholar 

  • Carmichael DG (2004). Project Management Framework. AA Balkema: Rotterdam.

    Google Scholar 

  • Clemen RT and Reilly T (2001). Making Hard Decisions with Decision Tools. Duxbury/Thomson Learning: Pacific Grove, CA.

    Google Scholar 

  • DTF (2010). The Practitioners’ Guide to Alliance Contracting, Department of Treasury and Finance (DTF), Melbourne, Victoria. www.dtf.vic.gov.au/project-alliancing, accessed 10 February 2011.

  • Eisenhardt KM (1985). Control: Organizational and economic approaches. Management Science 31 (2): 134–149.

    Article  Google Scholar 

  • Eisenhardt KM (1989). Agency theory: An assessment and review. The Academy of Management Review 14 (1): 57–74.

    Google Scholar 

  • Ekanayake S (2004). Agency theory, national culture and management control systems. The Journal of American Academy of Business 4 (1/2): 49–54.

    Google Scholar 

  • El-Sayegh SM (2008). Risk assessment and allocation in the UAE construction industry. International Journal of Project Management 26 (4): 431–438.

    Article  Google Scholar 

  • Gerybadze A (1995). Strategic Alliances and Process Redesign. Walter de Gruyter: New York.

    Book  Google Scholar 

  • Hauck AJ, Walker DHT, Hampson KD and Peters RJ (2004). Project alliancing at National Museum of Australia—Collaborative process. Journal of Construction Engineering and Management 130 (1): 143–154.

    Article  Google Scholar 

  • Holmstrom B (1979). Moral hazard and observability. The Bell Journal of Economics 10 (1): 74–91.

    Article  Google Scholar 

  • Holmstrom B and Milgrom P (1987). Aggregation and linearity in the provision of intertemporal incentives. Journal of the Econometric Society 55 (2): 303–328.

    Article  Google Scholar 

  • Howard RA (1988). Decision analysis: Practice and promise. Management Science 34 (6): 679–695.

    Article  Google Scholar 

  • Huang M, Chen G, Ching WK and Siu TK (2010). Principal-agent theory based risk allocation model for virtual enterprise. Journal of Service Science & Management 3 (2): 241–250.

    Article  Google Scholar 

  • Jensen MC and Meckling WH (1976). Theory of the firm: Managerial behavior, agency costs and ownership structure. Journal of Financial Economics 3 (4): 305–360.

    Article  Google Scholar 

  • Kirkwood CW (2004). Approximating risk aversion in decision analysis applications. Decision Analysis 1 (1): 51–67.

    Article  Google Scholar 

  • Kraus S (1996). An overview of incentive contracting. Artificial Intelligence 83 (2): 297–346.

    Article  Google Scholar 

  • Laffont JJ and Martimort D (2002). The Theory of Incentives: The Principal-agent Model. Princeton University Press: Princeton, NJ.

    Google Scholar 

  • Lahdenperä P (2010). Conceptualizing a two-stage target-cost arrangement for competitive cooperation. Construction Management and Economics 28 (7): 783–796.

    Article  Google Scholar 

  • Lambert RA (2001). Contracting theory and accounting. Journal of Accounting and Economics 32 (1–3): 3–87.

    Article  Google Scholar 

  • Love PED, Irani Z, Cheng EWL and Li H (2002). A model for supporting inter-organisational relations in the supply chain. Engineering Construction and Architectural Management 9 (1): 2–15.

    Google Scholar 

  • Love PED, Davis PR, Ellis JM and Cheung SO (2010a). Dispute causation: Identification of pathogenic influences in construction. Engineering Construction and Architectural Management 17 (4): 404–423.

    Article  Google Scholar 

  • Love PED, Davis PR and Mistry D (2010b). Price competitive alliance projects: Identification of success factors for public clients. Journal of Construction Engineering and Management 136 (9): 947–956.

    Article  Google Scholar 

  • Love PED, Davis PR, Chevis R and Edwards DJ (2011). Risk/reward compensation model for civil engineering infrastructure alliance projects. Journal of Construction Engineering and Management 137 (2): 127–136.

    Article  Google Scholar 

  • McGeorge D and Palmer A (2002). Construction Management New Directions. Blackwell Science: Oxford.

    Google Scholar 

  • Miller JG (2005). Solutions to Principal-agent Problems in Firms. Handbook of New Institutional Economics, Springer, Menard: Netherlands, pp. 349–370.

    Google Scholar 

  • Motiar Rahman M and Kumaraswamy MM (2002). Risk management trends in the construction industry: Moving towards joint risk management. Engineering Construction and Architectural Management 9 (2): 131–151.

    Article  Google Scholar 

  • Ouchi W (1979). A conceptual framework for the design of organizational control mechanisms. Management Science 25 (9): 833–848.

    Article  Google Scholar 

  • Perry JG and Barnes M (2000). Target cost contracts: An analysis of the interplay between fee, target, share and price. Engineering Construction and Architectural Management 7 (2): 202–208.

    Article  Google Scholar 

  • Puddicombe MS (2009). Why contracts: Evidence. Journal of Construction Engineering and Management 135 (8): 675–682.

    Article  Google Scholar 

  • Ross J (2003). Introduction to Project Alliance (On Engineering and Construction Projects). Alliance Constructing Conference: Sydney.

    Google Scholar 

  • Sakal MW (2005). Project alliancing: A relational contracting mechanism for dynamic projects. Lean Construction Journal 2 (1): 67–79.

    Google Scholar 

  • Sharma A (1997). Professional as agent: Knowledge asymmetry in agency exchange. The Academy of Management Review 22 (3): 758–798.

    Google Scholar 

  • Smith ME, Zsidisin GA and Adams LL (2005). An agency theory perspective on student performance evaluation. Decision Sciences Journal of Innovative Education 3 (1): 29–46.

    Article  Google Scholar 

  • Stevens DE and Thevaranjan A (2010). A moral solution to the moral hazard problem. Accounting, Organizations and Society 35 (1): 125–139.

    Article  Google Scholar 

  • Stroh LK, Brett JM, Baumann JP and Reilly AH (1996). Agency theory and variable pay compensation strategies. The Academy of Management Journal 39 (3): 751–767.

    Article  Google Scholar 

  • Walker DHT, Hampson K and Peters R (2002). Project alliancing vs project partnering: a case study of the Australian National Museum Project. Supply Chain Management 7 (2): 83–91.

    Article  Google Scholar 

  • Ward S and Chapman C (1994). Choosing contractor payment terms. International Journal of Project Management 12 (4): 216–221.

    Article  Google Scholar 

  • Willenbrock JH (1973). Utility function determination for bidding models. Journal of the Construction Division ASCE 99 (1): 133–153.

    Google Scholar 

  • Yeung JFY, Chan APC and Chan DWM (2007). The definition of alliancing in construction as a Wittgenstein family-resemblance concept. International Journal of Project Management 25 (3): 219–231.

    Article  Google Scholar 

  • Yeung JFY, Chan APC and Chan DWM (2011). Defining relational contracting from the Wittgenstein family-resemblance philosophy. International Journal of Project Management 30 (2): 225–239.

    Article  Google Scholar 

  • Zhao H (2005). Incentive-based compensation to advertising agencies: A principal-agent approach. International Journal of Research in Marketing 22 (3): 255–275.

    Article  Google Scholar 

Download references

Author information

Authors and Affiliations

  1. The University of New South Wales, NSW, Australia

    S M Hosseinian & D G Carmichael

Authors
  1. S M Hosseinian
    View author publications

    You can also search for this author in PubMed Google Scholar

  2. D G Carmichael
    View author publications

    You can also search for this author in PubMed Google Scholar

Corresponding author

Correspondence to D G Carmichael.

Appendix

Appendix

Derivation of the solution to the maximization problem presented in expression (5)

Consider both the owner and contractor to be risk-averse, though the level of aversion may range from very large to being risk neutral. Risk aversion is characterized by a concave utility function. Exponential, power and linear-exponential are candidate functions (Kirkwood, 2004). Here, the exponential utility function, because it has been popularly adopted (Holmstrom and Milgrom, 1987; Kirkwood, 2004), is used, and for the owner and the contractor, respectively, have the form,

Here r o and r c are the owner's and the contractor's level of risk aversion, respectively. The shapes of the owner and contractor utility functions change with r o and r c . Substituting Equations (A.1) and (A.2) into expression (5), differentiating the result with respect to Fee, setting to zero, and simplifying,

from which an expression for λ can be obtained. Taking the derivative of Equation (A.3) with respect to x gives,

Substituting λ from Equation (A.3) into Equation (A.4),

Equation (A.5) shows that the optimal gainshare/painshare contract depends on both the owner's and contractor's levels of risk aversion. Integrating Equation (A.5) with respect to x gives the optimal gain/pain sharing model, Equations (6) and (7).

Rights and permissions

Reprints and permissions

About this article

Cite this article

Hosseinian, S., Carmichael, D. Optimal gainshare/painshare in alliance projects. J Oper Res Soc 64, 1269–1278 (2013). https://doi.org/10.1057/jors.2012.146

Download citation

  • Received:

  • Accepted:

  • Published:

  • Issue Date:

  • DOI: https://doi.org/10.1057/jors.2012.146

Keywords

Search

Navigation