The Option to Change One Construction Contract for Another

The aim of this article is to propose a solution to the principal-agent problem arising in construction contracts. The inability to write complete and enforceable contracts gives the contractor the opportunity to earn by cheating. The ultimate method to deal with this problem is to design a contractual mechanism that would stop a self-interested contractor from taking benefit resulting from any post contractual opportunism. According to this method, the contractor must simultaneously enter into a cost-reimbursement contract and buy a call option for the work to be performed. This combination acts as if the owner enters into a costreimbursement contract and a fixed price contract with an exclusive right of choosing which contract to apply when the actual cost is known. The owner’s advantage lies in the power of preventing the contractor from behaving inefficiently. The contractor’s advantage lies in the possibility to demonstrate good faith and to make a credible promise without relying on reputation typically enjoyed by the already established contractors.