Decisions, Operations, and Technology Management

We study the problem of the manager of a project consisting of two sub-projects or tasks which are outsourced to different subcontractors. The project manager earns more revenue from the project if it is completed faster, but he cannot observe how hard subcontractors work, only the stochastic duration of their tasks. We derive the optimal linear incentive contracts to o.er to the subcontractors when the tasks are conducted in series or in parallel. We compare them to the fixed-price contracts often encountered in practice, and discuss when incentive contracts lead to bigger performance improvement. We characterize how the incentive contracts vary with the subcontractors’ risk aversion and cost of effort, the marginal effect of subcontractor effort, and the variability of task durations. We find that this dependence is sometimes counter-intuitive in nature. For instance, for parallel tasks, if the first agent’s task is on the critical path and his variability increases, the project manager should induce the first agent to work less hard and the second agent to work harder.