Optimal gainshare/painshare in alliance projects

Abstract

Alliances are popularly used in delivering infrastructure. However, discussion is ongoing as to what is the optimal gainshare/painshare arrangement. This paper derives a result for the optimal gainshare/painshare between risk-averse parties, where the level of aversion may range from very large to being risk neutral. The derivation is based on solving an optimization problem using concepts from agency theory. The influence of the parties’ level of risk aversion and outcome uncertainty is examined. Practitioners were engaged in a designed exercise in order to validate the approach and propositions. The paper shows that: (i) the optimal gainshare/painshare arrangement in alliances is linear in the project outcome; (ii) the optimal gain/pain share to the contractor should decrease with increasing contractor level of risk aversion and/or decreasing owner level of risk aversion; and (iii) the outcome uncertainty has no influence on the optimal gainshare/painshare. The paper provides those who write alliance contracts with recommendations on gainshare/painshare. This study casts new light on establishing optimal alliance arrangements in the construction industry.

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