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Department of Real Estate and Construction Management & Centre for Banking and Finance (cefin), Royal Institute of Technology Working Paper Series, Department of Real Estate and Construction Management & Centre for Banking and Finance (cefin), Royal Institute of Technology

No 15/2:
Moral hazard and construction procurement: A conceptual framework

Per-Erik Eriksson () and Hans Lind ()

Abstract: The first aim of this paper is to clarify the meaning of moral hazard in the context of construction procurement. Two important points are that typically there is a double moral hazard problem, as the client also can “misbehave” in a number of ways, and that both internal moral hazard (within the client and contractor organization) and external moral hazard (between client and contractor) must be handled.

The second aim of the paper is to give an overview of strategies to reduce the risk of moral hazard. Eight different strategies are identified: 1) “the shadow of the future”, promises of future work if effort is high 2) selection mechanism for contractor/employee, 3) length of contract, length of warranties, 4) level of detail in the contract, 5) payment systems, 6) monitoring intensity, 7) social norms, and 8) relation specific investments.

At the end of the paper a number of questions for future research are identified. Can the strategies be grouped into an ideal type of hard/formal strategies (with e.g. detailed contracts, more monitoring, and choose the bidder with the lowest price) and soft/informal strategies (with e.g. long term relations and more flexible contracts)? How are methods used internally and methods used externally to reduce moral hazard related? What are the differences in these respects between private sector procurement and public sector procurement methods?

Keywords: moral hazard; procurement; (follow links to similar papers)

JEL-Codes: R32; R38; (follow links to similar papers)

26 pages, January 26, 2015

This paper was written as part of the ProcSIBE-project (Procurement for Sustainable Innovations in the Built Environment.

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