Bid calculation for construction projects: Regulations and incentive effects of unit price contracts

The Austrian contract awarding system for construction projects is characterized by the unit price contract being an important contract type. The bid price is a decisive criterion for the selection of the construction company that performs a project, and the bid price is calculated from the unit prices and the specified production volumes of the project activities. Since the actual production volumes can differ from the specified volumes, the actual payment can differ from the bid price according to these deviations. In practice there can be asymmetric information on the production volumes. This leads to an incentive for the bidders to ‘skew’ the bid calculation by asymmetric allocation of overhead costs to project activities. In this paper we analyze this agency-theoretical situation and develop a model that decides on the allocation of overhead costs to project activities in order to maximize the actual payment for a predetermined bid price. We also present a case study and comment on the implications of the model for the contract awarding system in the construction industry.