Using Nash bargaining to design project management contracts under cost uncertainty

In the design of procurement contracts, cost sharing, wherein the contractor receives a fixed fee plus a fraction of his cost, is common when the cost for completing the project is uncertain. We determine the best cost-sharing contract between a risk-neutral project manager and a risk-averse contractor when negotiation proceeds in accord with Nash bargaining. We examine the characteristics of the contract when the contractor can invest to reduce the mean and/or the uncertainty of the project cost. We show that cost-plus contracts dominate fixed-price contracts as well as all other cost-sharing contracts. In order to extend our analysis to the case when the value of the project itself is uncertain, we employ the recent method of embedded Nash bargaining. Finally, we generalize our main result by allowing an asymmetric Nash bargaining solution.