The impact of principal–agent relationship and contract type on communication between project owner and manager (Müller & Turner, 2005)

Communication and Contract type

Müller, Ralf; Turner, Rodney J.: The impact of principal–agent relationship and contract type on communication between project owner and manager; in: International Journal of Project Management, Vol. 23 (2005), No. 5, pp. 398-403.

Müller & Turner argue that a project should be analysed in two distinctive stages pre and post contract. The pre contract perspective follows the laws outlined in Transaction Economics (or Transaction Cost Theory), which postulates that companies choose the governance structure with the lowest transactions costs. Specifically the degree of asset specificity, the degree of uncertainty, and the frequency of transactions determine the transaction costs both parties (vendor and buyer) consider in this phase.

The post-contract perspective is best conceptualised by the Principal-Agent-Theory, specifically by with the phenomena of moral hazard and adverse selection. Game theory usually calls this equilibria with correlated strategies and calls for contractual design in a way that each player is receiving incentives for compliance.

On a side-note: This behaviour is a classical chicken game. Imagine a vendor and a buyer who build up an integrated team. Both agree (orally) to send their most experienced experts (unfortunately they cost more), which would be best for the project work to be done. In this game each party can choose to give the work either to experts or to rookies:

  Rookies Experts
Rookies (0,0) (8,2)
Experts (2,8) (6,6)

Thus it is better for each team to sent rookies if the other team sends experts (which gives us the two Nash-equilibria of the game). If vendor and buyer send their rookies no one will know what is going on and what they have to do and both earn nothing (0,0). On the other hand the oral agreement of both parties to send their experts is not credible. Since this is a one-shot game the strategy (6,6) can only be reached if both parties agree on binding contracts or a negotiator.

Müller & Turner show that decisions made in the pre-contract phase with the objective to minimize the transaction costs (e.g. fixed-price or cost-plus contracts) can potentially have
have adverse effects on the project in the post-contract phase – by increasing the administrative costs for communication due to their negative impact on owner–manager

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