Time is Money: Optimal Investment Delay in Procurement (and Concession) Contracts

Procurement (and concession) contracts are agreements granting the right to construct public works, operate and provide a service/good. Themain advantage of a procurement contract is that it passes full responsibility for investment and operations to the private sector and consequentlyprovides incentives for efficiency. Although most contracts include penalty/premium clauses to avoidconstruction risks (i.e. delays), evidence from ongoing procurement contracts shows that there are many delays in making investments. Actuallythese clauses introduce the flexibility to decide when it is optimal to invest and consequently increase the contract’s value for the contractor. Therefore if the contracting authority underestimates penalty/premium fees, these may be totally ineffective in avoiding construction risks.In this paper we specifically investigate the effects that penalty/premiumclauses have on both contract value and reduction of delay. We also focus on the design of optimal penalty/premium rules.