Economic Principles of Contractor Compensation

The Construction Industry Institute (CII) has formed the Contractor Compensation Research Team, charged with identification of innovative compensation methods that can dramatically improve engineering and construction contractors' performance relative to facility owners' objectives. Research methodology has included a review of relevant literature in construction engineering and economics, a survey of owners and contractors to identify innovative compensation mechanisms in use, and structured interviews of project teams to explore contract terms and their impact on performance. The literature review was undertaken early to provide a framework for the research and to illuminate underlying economic principles that could point to innovative contracting solutions. Based on that review, this paper presents economic theory pertaining to engineering and construction contracting, using for illustration the experiences of actual project teams. Principles for design of contractor compensation, as suggested by economic theory, are illustrated with engineering and construction contracts observed by the research team.