Optimal time‐based and cost‐based coordinated project contracts with unobservable work rates

When managing a project with uncertain completion time and unobservable contractor's work rate, self‐interest can create conflicts between the project manager and the contractor leading to actions that reduce the profits of both. We first investigate how the concept of supply contract coordination (i.e., a Nash equilibrium that yields the first‐best solution for the entire supply chain) can be applied to project contract management. In our examination of three types of project contracts commonly used in practice, fixed price, time‐based (i.e., price depends on the realized project completion time), and cost‐based (i.e., price depends on the actual cost), we show that fixed price contracts and cost‐plus contracts cannot coordinate a channel. With carefully chosen parameters, however, time‐based, cost‐sharing can achieve optimal channel coordination.