Resolving agency issues in client-contractor relationships Resolving agency issues in client-contractor relationships Resolving agency issues in client-contractor relationships A FACELIFT FOR A 350-YEAR-OLD COMPANY which are to be decommissioned. The restaurant will become a meeting place for Resolving agency issues in client-contractor relationships: In 2015, after several large acquisitions transformed its businesses, Merck KGaA' underwent numerous employees from the various parts of the site." The Merck Innovation Center a re-branding into the single brand Merck. Merck is a diversified pharmaceutical, life sciences and chemicals group founded in 1668 and ever since headquartered in Darmstadt, Germany The company employs approximately 52,000 people around the world, with 11,000 in North America and about the same number in Germany (Merck, 2019). The company invested Christine Unterhitzenberger, Lancaster University and Dietmar Moller, Merck KGaA US$ 565m in Capex world-wide in 2015, including a large number of construction projects (Merck, 2016). ABSTRACT The new brand was designed to position the organization as an innovative science and technology company as prior analysis suggested that its culture had to undergo a The management of relationships has been acknowledged as a crucial element of project transformative change. It was als ecognized that architecture, in particular at the success. However, agency related issues such as goal conflict, information asymmetry or headquarters, conveys a strong message to customers, partners, the community, and opportunistic behavior can make this a real challenge. Steven and Mark - program employees and that the architecture needs to represent the transformative change as well. managers for One Global Headquarters at Merck - developed their own way on how to deal On this basis, the program One Global Headquarters (OGHQ) was initiated in 2014 with the with this challenge in a complex and uncertain environment. This case study will provide aim of completion by 2018, when the company celebrated its 350-year anniversary. The unique insights into their approach and motivation. program consisted of about 90 interdependent construction projects of various sizes, shapes and forms at the headquarters in Darmstadt with a total ent of more than US$ 200m. The program was led by two internal managers - Steven and Mark - who mainly focused on KEYWORDS: project management, agency theory, project success, principal agent strategy and governance issues and were supported by a program management team of relationship internal and external experts to oversee the high number of projects. External experts were hired in all cases, in which internal resources were considered inadequate or insufficient to stay in control of architectural quality, schedule and budget, all of which were non-negotiable. At the heart of the program was the development of the Innovation Center and the adjacent Employee Restaurant (Figure 1 and 2), which was described by its architects Henn as follows (Henn, 2019): Fig. 2 Typical floor space in the Merck Innovation Center (reproduced with permission from Esch (2018)) "The Innovation Center will be used to cooperate temporarily in interdisciplinary teams and to communicate both internally and externally. While the newly developed public square (...) orientates the company towards the city, the Innovation Center EUROPE'S LEADING CONSTRUCTION MARKET opens it to the interior. There are three levels which are set back from one another so The context for this case study is Europe's leading construction market with the continent's that they are to a large extent visually linked. Levels can be changed using arched largest building stock: Germany. The construction sector in general is one of the largest ramps. These connections, like the the segments at individual levels, contributors to the world economy and a key industry in most countries. A recent global are highly frequented meeting pla direct exchange of information survey found that the productivity of the sector has by far trailed that of almost all other among knowledge holders is enc uraged. In passing, building users can be inspired industrial sectors over the past decades, thus offering huge opportunities for improvement by the work of their colleagues and prompted to engage in discussions. Different (Barbosa et al, 2017). While it was found that low productivity performance in construction is demands on the workplaces - concentration, communication, cooperation - find not uniformly distributed, with big variations between countries and subsectors, there are still spatial expression in a flowing transition. Team communication takes place in the common reasons for it. Among those reasons stands the observation, that spacious internal area on each floor. Single-person office cells along the facade provide space for activities requiring concentration and intensive thought. The company restaurant is connected to the Innovation Center on several levels. It will assume essential functions on the currently decentralized staff canteens, some of "Construction is highly fragmented. Contracts have mismatches in risk allocation and rewards, and often inexperienced owners and buyers find it hard to navigate in an opaque marketplace. The result is poor project management and execution, Founded in 1688 in Darmstadt, Germany, Merck is the world's oldest pharmaceutical and chemical company. In the 19th insufficient skills, inadequate design processes, and underinvestment in skills century, the success of its export business to the United States led to the establishment of an office in New York in 1887, which development, R&D, and innovation. " (Barbosa et al, 2017, p. 8) Fig.1 Merck Innovation Center and Emmanuel-Merck-Platz in Darmstadt, Germany (reproduced with gave rise to the establishment of a separate entity four years later. In 1917, during World War | it was expropriated. Ever since, permission from Esch (2018)) Merck KGaA and its affiliates are named simply "Merck", In the United States and Canada. Merck KGad uses its firm name "Merck KGaA Darmstadt Germany," and its businesses operate under "EMD Serono" in bicpharma, "MilliporeSigma" in life science and "EMD Performance Materials" in the materials business The other company. Merck & Co., Inc., Kenilworth NJ. US The study concludes that market failures and external factors compromise how the industry holds the rights in the trademark MERCK in the United States and Canada. All references to the name Merck in this case study efer exclusively to the former. functions and result in low productivity of firms of all sizes. Overall, low labor productivity, asResolving agency issues in client-contractor relationships Resolving agency issues in client-contractor relationships Resolving agency issues in client-contractor relationships well as poor project management can be directly linked to project failures in terms of cost is always lost, if the runner doesn't get a good start. This theme became a proverb in the design for the tendering documents was based upon, were exacerbated at a late stage overruns and delays that are often observed in construction projects. program. during the procurement phase, rendering several requirements and material take-offs' The German construction sector is a good representation of this situation. The above- Steven and Mark are supported by a team of internal and external experts. Within the obsolete in some parts. As the timely laying of foundations was imminent, certain structural mentioned study finds it to be almost average-ranking in terms of both construction labor program, Claire is the project manager for the Innovation Center and Employee Restaurant. design questions relevant to pricing had to be put to rest during the procurement process productivity and its growth. In 2018 the industry's added value contributed US$ 178bn or Claire is a qualified architect, who worked as an independent architect before joining Merck under the mutual understanding that they were to be sorted out fairly later on. Steve and 5.3% to the German economy (Statistisches Bundesamt, 2019). During the past decade, 20 years ago. She has been trusted with major and important construction projects since. Mark were confident that their collaborative approach would be able to accommodate this after a cyclical downturn of the industry, many large national construction firms, whose core Based upon her track record, Steven had lobbied hard to have her assigned to the program. difficult situation. Otherwise an incomplete design basis would result in extensive claims or competence was the efficient execution of large turn-key construction projects, left the Other key players were Peter, the architect's project leader who had the overall responsibility overpricing due to incalculable risks, which they obviously wanted to avoid market and their place was taken by medium-sized, often family owned, companies for the design of the buildings as well as the construction management, and John, the specializing in particular trades such as concrete works, facade-works or interior fit out. structural engineer, who had to find ways to make Peter's ambitious design feasible and Architects typically work in small- to medium-sized specialized practices and subcontract affordable while also complying with building regulations. John heads the Berlin office of his engineering design work to specialized engi eering firms. Deliverables, their quality and, to structural engineering company, which is one of the best in the country with a vast some extent, the fees of architects and engineers are regulated by national legislation. experience in challenging designs. Peter led many ambitious construction projects for large t has been widely argued that contractors, like all other partners in a project, should become corporate clients in Germany and China and is supported by Paul, a civil engineer by fully involved as early as possible in order to participate in the evolution of the final design by training, who successfully acted as a construction nager for various projects. contributing their knowledge and expertise and become an integrated network partner. Worth mentioning here are also Frank, who is Merck's procurement manager for the However, many public and private clients defer the final investment decision by means of program with an engineering background, and Lilian, a civil engineer and quantity surveyor. their corporate governance until basic design is completed and cost estimates by the who is part of a team of external specialists from the project management consultancy Drees consultants become fir Hence, only after the final investment decision is made by the & Sommer. She and her team were specifically hired for the program to complement all client, the architect and engineers start to prepare the tendering documents for all trades and equired competences of the program management team. procurement packages in order to avoid sunk costs in case the final investment decision is negative. Various different procurement models are available, whereas the traditional competitive tendering is still prevalent. More innovative methods like open book contracts are CONCRETE AND STEEL WORKS - BACKGROUND in its infancy in Germany and many clients and contractors do not know how to accommodate them in their corporate governance and are not familiar with the required Considering the general environment outlined earlier, Steven and Mark were faced with a changes in behavior and attitude. dilemma: they either follow the traditional way of procurement through competitive tendering, which is likely to create the basis for an adversarial environment with all its negative Many spectacular project failures both in the public as well as in the private sector have been Fig. 3 a and b: Concrete ramps in the MIC during construction and upon completion (reproduced with consequences, or they use more innovative forms like open book contracts, which are permission from Esch (2018)) credited to an adversarial and fragmented project environment based on suboptimal difficult to accommodate within Merck's corporate governance and the industry isn't very contractual arrangements that often resulted in claims and litigation. Major customers and powerful players of the German construction industry have recognized the necessity of better familiar with them either. However, they did not want to adopt an only partially suitable solution and decided to explore new co collaborative ways of selecting contractors. They were collaboration and better contracts with their initiative TeamBuilding under the slogan "For a conscious of some of the issues often pres ent-contractor relationships like goal Better Collaboration in the Construction Industry", which was started in 2017 (Initiative Teambuilding, 2019). conflict, information asymmetry, trust or opportunistic behavior and tried to identify ways to overcome these. They assumed that these issues contribute to the adversarial environment and hence, are inhibitors of project success. As the OGHQ program had very high strategic importance within Merck, Steven and Mark did not want to risk the project being late, over ONE GLOBAL HEADQUARTERS - THE MAIN ACTORS budget or of mediocre quality. Based on the procurement of concrete and steel works for the As previously mentioned, the OGHQ program was led by Steven and Mark. Steven is a Innovation Center and Employee Restaurant their approach to collaborative procurement is program and project manager with more than 30 years' experience. He is a chemical explained in the following. engineer with a PhD by training, however moved into the management of major projects The tendering package for concrete and steel works was chosen for two reasons: Firstly, the within Merck several times during the past 20 years. Since then he has been responsible for intricate architectural design was highly challenging as it required complicated and fair-faced Fig. 3 c and d: View into a stair well during construction and upon completion (reproduced with R&D, construction and organizational projects ranging from tens to several hundred million concrete surfaces, wide ceiling spreads, and floors resting on very few supporting pillars (see permission from Esch (2018)) US$ with the OGHQ program being the largest and most important so far. His background Figure 3a to d). To build such a complex concrete-cum-steel structure without flaws requires gives him a very good understanding of the client's organization as well as project a tremendously high quality of craftmanship in formwork, ironworks and concrete works, governance. Mark is a qualified architect and joined Merck only shortly before the program which only few contractors are able to deliver. In such a case it is paramount for the project's by direct initiative of Merck's CEO. He has a long career in the construction industry with vast eventual success, that the bidding contractors do not under-estimate the complexity and experience as architectural lead for a major contractor in Germany. This gives him specific difficulties of the required work and erroneously bid too low or beyond their capabilities. expertise in architecture as well as in the nuances of the German construction market. He Hence, Steven and Mark concluded that in such a case tendering cannot be conducted Material take-offs are used in engineering and construction and the term refers to a list of materials with quantities and types likes to stress the need for a good start in any project and compares it to a 100m sprint that based on price only, but that a collaboration based on trust needs to be developed with the (such as specific grades of steel) that are required to build a designed structure or item. This list is generated by analysis of a blueprint or other design document. contractor to manage the complexity of the project. Secondly, requirements the structuralResolving agency issues in client-contractor relationships Resolving agency issues in client-contractor relationships Resolving agency issues in client-contractor relationships CONCRETE AND STEEL WORKS - PROCUREMENT PROCESS Claire explained rationale and situation of the project, in particular the challenging time-line Shortly after the project had reached this stage, additional regulatory requirements were During the pre-contract phase Steven, Mark and Claire put a high emphasis on the quick that was given the highest priority by Merck, as well as the organization of the construction issued by the building authority in terms of unexpected explosion events. These build-up of project knowledge with the potential contractors who were about to join the site; Peter explained building concept and design and presented examples and challenges in requirements had not been known earlier and several parts of the tendering package had to bidding process. Naturally, there is a big information asymmetry about the project and the making the fair-faced concrete surfaces; John explained the structural design concept and be re-worked by the planners (stage 7). This was a major issue for Steven and Mark as they nature of the task between the principal partners, i.e. client, architect, engineers - who have Paul and Lilian captured feedback on a previously drafted schedule considering site logistics were aware that Merck would not accept any delay of the set completion date due to the worked on the project for months or - and the incoming bidders - who are just and interdependencies with other contractors. After this introduction, technical questions by celebrations planned for the company's 350-year anniversary. Work on foundations had to the bidders were addres familiarizing themselves with the material d - which puts the latter at a disadvantage start soon, and hence, they decided together with Peter and John that further talks should Steven, Mark and Claire had planned to overcome this information asymmetry through a This workshop was specifically designed to establish a good working relationship and concentrate on the two most promising bidders - namely Construct (A) and Build (B). dedicated information exchange including discussions with all bidders on an individual basis demonstrate the collaborative approach chosen for this project. However, discussions on Construct and Build were asked for indicative quotes based on some initial information (1=3; throughout the procurement process, which is summarized in Table 1. This also allowed pricing were completely excluded at this point and the bidders were asked to prepare their stage 8). Afterwards, both were invited to individual risk mitigation meetings in order to hem early on to build a collaborative relationship based on trust with the bidders which they quotes under due consideration of the workshop results. explore the most suitable way forward to minimize negative consequences of the re-design in hoped would be carried through to the post-contract award phase of the project. Three bidders refrained from submitting a quote after the workshops, whereas the remaining a collaborative spirit (stage 9). These face-to-face meetings were centered around: five submitted their quotes on time (stage 4). As shown in Figure 4, quoted prices were Stage t Tendering activity Bidders Calendar week spread out significantly at this point (1=1) with a variance of more than 50%. After evaluation . Full disclosure of the regulatory situation and their influence on the building 2015 of the quotes the bidders were invited to another set of individual workshops (workshop 2) structure Request for interest in bidding 4- 12 which were centered around the results of the Lilian's and Peter's check and individual items . Request for ideas and optimization potentials with respect to works preparation Distribution of original tender 13 of the quotes, where pricing appeared to be off or inconsistent (stage 5). As a result, the two and sequences in order to accelerate construction. documents lowest priced bidders raised their price, whilst the most expensive one lowered his, and the . Options to bring materials purchases forward on the basis of draft material Individual workshops - workshop 1 6-1 spread in pricing of the now technically comparable quotes had fallen by half (1=2; stage 6). takeoffs and fair allocation of corresponding risks as well as shift work on site. (1) Submission of quotes All these intensive discussions al ed interesting insights for Steven, Mark and their Individual workshops - workshop 2 team into competence and general attitude of the bidder and their representatives, who were During the workshop the bidders were also provided with the revised material take-offs and (2) Revision of quotes #1 about to become future partners in the project. This allowed them to draw conclusions on the other documents that had changed. Based upon all available information, the final quotes Amendment of tender documents 27 - 2 contractors' collaborative approach and how it developed over time, i.e. they could see if were submitted by Construct and Build (stage 10). As indicated in Figure 4, the final quotes based on new regulatory collaboration is really engrained in the contractors' thinking and doing or if it is just a were higher than the previous, indicative ones because quantities and qualities of steel and requirements and marketing approach concrete had increased due to higher design loads (1=4). (3) Submission of indicative quote Individual risk mitigation workshops NN In parallel, Peter, Lilian, and Paul adjusted the time schedule accordingly under inclusion of - workshop 3 160% optimization proposals by the bidders in order to evaluate the consequences on other 10 (4) Revision of quotes #2 contractors. Steven, Mark and their team then evaluated the two quotes with Construct Contract negotiations offering the best value. They visited an example project of Construct and decided to move to Contract signed $ 140% technical contract negotiations with them. During these negotiations they agreed the following: Table 1. Procurement process; disturbance symbol () represents changed requirements. Bidder A 120% X Bidder B Planned delivery and contract dates relative quoted price Concept for organization and sequence of construction Steven, Mark and their team intended to achieve the following objectives with this approach: Bidder C OX DO D Site organization 100% Bidder D Contingencies in case of adverse weather conditions Build a mutual understanding of technical and qualitative building requirements. Bidder E Secondary offers for optimizations Familiarize bidders with the planning content of the previous design work as well as its limits and challenges. Only after these conditions were fixed, the price was negotiated, as per Merck's corporate 80% Clarification of technical issues and time schedules for both sides. governance under Frank's lead, and subsequently the contract signed. These negotiations t=2 1=3 Preparation of a common basis for realistic and comparable pricing. were conducted in a constructive atmosphere of mutual respect and fairness. After signing To become mutually acquainted with the acting persons and creation of a mutual the contract, Merck offered Construct unilaterally additional bonus payments, if certain base of understanding and trust. milestones were met. The idea was to motivate them to achieve targets and to demonstrate Fig. 4 Pre-Contract phase: Development of quoted prices for the concrete and steel works package goodwill and good intentions for further collaboration by offering a bonus which could not be Claire and Frank identified 23 pre-qualified contractors who they provided with a brief (normalized with the final contract price = 100%) over the year 2015. interpreted as a withheld portion of the earned payment for services. The bonus arrangement introduction to the project and asked for an expression of interest for inclusion in the bidding gave Claire a lever to directly influence Construct's management with regard to directing process (stage 1). They received 14 positive responses and sent the full tendering package to these contractors (stage 2). Upon closer inspection of the information provided, six hese particular buildings, an additional regulatory requirement was imposed by the local building authorities owing to the contractors decided not to engage in the bidding process any further and the remaining eight fact that the buildings are placed close to chemical plants that pose a potential danger from industrial accidents. One such were invited to individual day-long workshops (stage 3). During the workshops (workshop 1), in engineering terms and had to be investigated thoroughly by highly specialized consequences for sizing facade and structural work became entirely dear.Resolving agency issues in client-contractor relationships Resolving agency issues in client-contractor relationships Resolving agency issues in client-contractor relationships extra effort towards meeting important and evolving milestones at her discretion, which is Bryde, D., Unterhitzenberger, C. and Joby, R. (in press) Resolving agency issues in otherwise difficult to do under German law. Resolving agency issues in client-contractor relationships: The Merck Innovation Center client-contractor relationship. Production Planning & Control Instructor's guide for teaching case For further information about the project in relation to architecture, photography and CONCRETE AND STEEL WORKS - EXECUTION innovation, it is recommended to read the following book as it offers many visual and intellectual insights into the project (in German and English). It is not a requirement to read During execution of the contract Claire, Lilian and Paul regularly met with Construct's project this book in order to understand and work with the case. management and monitored the work done on site. Technical and organizational issues were ABSTRACT discussed as were progress, obstructions, safety and order on site, as well as logistics. Esch, H. G. (2018) Merck Innovation Center, Wasmuth Verlag, Tubingen. This teaching case focuses on agency issues in project management using a large corporate Solutions to problems were sought jointly, and if unavoidable, intermediate milestones were construction project as empirical context. It is mainly focused on the procurement strategy The students should be given the case prior to the teaching session to read in depth, so that adjusted and individual bonus payments offered, whilst keeping the project end date fixed. and process of one specific work package through a collaborative approach which aims to the time in the classroom can be used for discussions. Additional work requests were regularly negotiated in a mutually fair manner. build trusting relationships between the - and the agent - the contractor. The contractual work had been delegated to the Construct team who remained fully The project faced a multitude of challenges which will be discussed. It will enable students to responsible for execution and output. John regularly supervised critical stages of structural gain an in-depth understanding of agency related issues and to develop the skills to design Teaching methods work and Mark, Claire and Peter checked the critical fair-faced concrete surfaces. Steven appropriate procurement strategies considering agency issues in complex project kept loose contact to the senior management team of Construct and got slightly more environments This case enables lecturers/tutors to use a problem-based approach to learning in a small group teaching environment. Due to the nature of the intended audience - executive involved in rare cases of dissent between the two project teams. He chose this approach to education and post-experience students - small group teaching is recommended. It will allow keep both parties focused on work execution, rather than on questions of accountability or INTENDED AUDIENCE the students to use their k he small group discussions, to build individual contractual interpretations. on others' existing work and to think creatively ally in order to solve the problem REFERENCES The intended audience for this case is participants of executive education programs or short they are presented with. The teaching case and its discussion questions provide the problem courses as well as professionals who attend in-house training. Hence, it is assumed that for the students which they are required to solve through these small group discussions. Barbosa, F., Woetzel, J., Mischke, J., Joao-Ribeirinho, M., Sridhar, M., Parsons, M., Bertram, participants who have a certain amount of work experience and who can relate the case to They need to work out themselves how to solve this problem, which enables them to develop N. and Brown, S. (2017) Reinventing Construction: a Route to higher Productivity. Mckinsey their experience will use the case. Examples of courses this case is suitable for are modules transferable skills, improve team working and communication and enhance debating and Global Institute. (Available at www.mckinsey.com/mgi; accessed: 22. May 2019) on project organization or governance on MSc project management programs, which require analytical skills. Esch, HG (2018) Merck Innovation Center, Wasmuth Verlag, Tubingen. prior work experience or short courses for practitioners, which address topics like collaborative working, procurement strategies for projects or project deally, the use of this case should be structured as follows (duration 90 minutes): Henn, G. (2019), private communication organization/governance. The case is designed to be one element of 90 minutes to support 10 minutes Re-cap on agency theory and agency-related issues Merck (2019) Corporate Responsibility Report. (Available at: https://www.merckgroup.com; he delivery of the course, but it should not be used as case for the entire course. 5 minutes Summary of the case by the students accessed 22.05.2019) 2 minutes Forming of small groups (2 - 4 students per group) Merck (2016) Annual Report 2015 (Available at: http://ar2015.merckgroup.com; accessed LEARNING OBJECTIVES 22.05.2019) 3 minutes Handing out of discussion questions After analyzing this case, students should be able to: Statistisches Bundesamt (2019) Volkswirtschaftliche Gesamtrechnungen - 30 minutes Small group discussions on discussion questions 1 - 10 Inlandsproduktsherechnungen. (Available at: https://destatis.de; accessed: 22 May 2019) 1. Evaluate the presence of agency related issues in client-contractor relationships 2. Develop methods to overcome agency related issues in client-contractor relationships 30 minutes Discussion of the answers with the full cohort Initiative Teambuilding (2019) Initative Teambuilding (Available at: https://initiative- 3. Operate appropriate procurement strategies for complex projects 5 minutes Presentation of the epilog teambuilding.de/; accessed: 22. May 2019, German only) 4. Assess benefits and weaknesses of collaborative approaches in projects 5 minutes Open Q&A around the case and the epilog ACKNOWLEDGEMENTS The research team is grateful to all informants of this research who provided support for the TEACHING STRATEGY advancement of knowledge. In particular we would like to thank the client, Merck KGaA, the LITERATURE REVIEW, THEORY AND RECOMMENDED READING external project managers, Drees & Sommer AG, the architects, Henn Architecture and the Case preparation Agency theory has its origins in economics of the 1960s and 1970s where researchers photographer, HG Esch. As outlined earlier, this case can be used on programs and modules related to post explored how individuals and groups share risks and how it creates problems when the COPYRIGHTS experience education in project management. Students working on this case should be involved parties have different attitudes towards risks (e.g. Arrow, 1971; Wilson, 1968). It familiar with different procurement methods for projects including contracting/outsourcing as was then developed further to incorporate issues such as diverging goals of cooperating Copyright Photographs @2018 Hans Georg Esch All Rights Reserved; Contents and well as project organization and project governance. No detailed knowledge in these areas is parties and division of labor, which created what is now known as the 'agency-problem' compilations published in this case study are subject to German copyright laws. required, but they should be familiar with the related terms and processes. (Jensen and Meckling, 1976). In essence, agency theory focuses on the dyadic relationship Reproduction, editing, distribution as well as the use of any kind outside the scope of the between two cooperating parties: the principal, who delegates work to the agent, who copyright law require a written permission of the authors. Copies of the material are To prepare the students for this particular case it is recommended that they read the performs the work, whereas the relationship is defined through a contract (Eisenhardt, 1989). permitted for private and educational use only. The commercial use of our contents without following paper prior to working on the case to provide them with the required theoretical background on agency theory: This type of relationship is omnipresent in many multi-organizational projects where a client permission of the authors is prohibited.Resolving agency issues in client-contractor relationships Resolving agency issues in client-contractor relationships Resolving agency issues in client-contractor relationships (the principal) engages external consultants or contractors (the agents) to execute work, completeness relates to the extent the contract is fit for purpose (Handley and Benton Jr, 5. Steven and Mark decided to develop their own collaborative way of procuring usually due to a lack of expertise or resources in-house. It has been recognized as a useful 2009) concrete and steel works. Do you think their model should be recommended for and realistic theory for exploring cooperative relationships (Eisenhard, 1989) and has been This teaching case sheds light on some important aspects of agency theory including replication for other projects? Why? applied as a theoretical lens for project governance research (Turner and Muller, 2003). agency-related issues and their potential resolutions - especially during the procurement 6. Due to the introduction of additional requirements by the building authorities a major Agency theory is interested in solving two main problems: the adverse selection problem and process - for a large-scale construction project. disruption of the procurement process occurred. Do you think Steven's and Mark's the moral hazard problem. The adverse selection problem refers to the information strategy to postpone this issue post-contract award is suitable? Why? asymmetry between the principal and the agent (Akerlof, 1970), as one party usually has 7. Post-contract award the client offered bonus payments to Construct. Why did they more or better information than the other party. An example situated in the project context is, choose to spend extra money if they are not contractually obliged to do so? Do you Recommended reading that it is often the case that the agent, i.e. the contractor, has significantly more detailed think it paid off? information about how the project is performing than the principal, ile. the client, who might Eisenhardt, K. (1989) Agency theory: An assessment and review. Academy of Management B. Bryde et al (in press) point to another area, where agency problems arise, namely in also be not in the position to verify the information provided by the agent (Wiseman et al, Review, 14(1), pp. 57-74 the allocation of benefits and risks in uncertain situations. Which instance in the case 2012). This can subsequently lead to the moral hazard problem where the agent engages in study addresses this particular concern of Steven and Mark? Did they adopt a value actions, which put a specific risk on the principal, knowing that the principal will have to incur or a risk sharing perspective? Why? the consequences (Eisenhardt, 1989). References 9. Would you have done anything differently to Steven and Mark? Why? 10. In your opinion, is it likely that Steven's and Mark's approach contributes to the Common issues related to the adverse selection and the moral hazard problem are (Bryde et Akerlof, G.A. (1970) The Market for" Lemons": Quality Uncertainty and the Market success/failure of the project? Why? al, in press): Mechanism. The Quarterly Journal of Economics, 84(3), pp. 488-500 Goal conflict - Each party will follow their own interests and not act in a way, which is Arrow, K. (1971) Essays in the theory of risk bearing. Markham, Chicago. ANSWERS TO DISCUSSION QUESTIONS mutually beneficial if the goals of the cooperative relationship are not aligned or not known. Bryde, D., Unterhitzenberger, C. and Joby, R. (in press) Resolving agency issues in client- Opportunistic behavior - One of the parties operates in an opportunistic way, i.e. they contractor relationship. Production Planning & Control 1. Which agency related issues can you identify in the case? exploit a situation by aiming to maximize their economic self-interest accepting that Eisenhardt, K. (1989) Agency theory: An assessment and review. Academy of Management Agency issues emerge due to the phenomena of adverse selection and moral hazard. this might lead to the loss of a partner. Review, 14(1), pp. 57-74 Adverse selection relates to the information imbalance between the agent - in our case the Information asymmetry - The principal and the agent do not have access to the same bidders - and the principal - in our case Merck as the client and the consultants - mainly information and/or are not willing to share their information. Florical, S. and Lampel, J. (1998) Innovative contractual structures for inter-organizational during the pre-contractual procurement process; whereas moral hazard relates to situations Trust - The two parties trust each other if they have a firm belief in the reliability, truth systems. International Journal of Technology Management, 16(1), pp. 193-206 where the principal has difficulties directing the agents actions because they are and ability of each other. Principal-agent relationships are often characterized by a Handley, S.M. and Benton Jr., W.C. (2009) Unlocking the business outsourcing process unobservable or cannot be contractually agreed and hence, occurs in the post-contract phase. Our case is situated during the pre-contractual procurement process, so the focus is high level of mistrust. model. Journal of Operations Management, 27(5), pp. 1540-1556 on the adverse selection problem and more specifically on the following issues: Verification of contractor performance - The principal does not have any means of verifying the contractor's performance and hence, cannot validate if the information Jensen, M., and Meckling, W. (1976) Theory of the firm: Managerial behavior, agency costs, provided is correct or not and if the project is on track or not. and ownership structure. Journal of Financial Economics, 3. pp. 305-360 Degree of goal conflict - It is highlighted in the text that "many spectacular project failures both in the public as well as in the private sector have been credited to an Concealment of negative outcomes - One of the parties withholds or suppresses Joslin, R. and Muller, R. (2016) The relationship between project governance and project adversarial and fragmented project environment based on suboptimal contractual negative outcomes of their work. Either the principal or the agent do not share success. International Journal of Project Management, 34(4), pp. 613-626 arrangements that often resulted in claims and in litigation". This is related to the problems and failure and do not give the other party the opportunity to contribute to degree of goal conflict as an adversarial environment often develops when the the rectification. Turner, J.R. and Muller, R. (2003) On the nature of the project as a temporary organization. involved parties have opposing or non-aligned goals. This can typically occur in two International Journal of Project Management, 21 (1), pp. 1-7 different situations: a) when contractors are either predominantly interested in These issues are all inter-related and cannot be isolated from each other, as e.g. information maximizing their own profit and hence, do not necessarily act in the interest of the asymmetry can lead to mistrust and opportunistic behavior or goal conflict can lead to Wilson, R. (1968) On the theory of syndicates. Econometrica, 36, pp. 119-132 project/client or when the contractor representative follows his/her own agenda in opportunistic behavior or concealment of negative outcomes. Many principals, i.e. clients, Wiseman, R.M., Cuevas-Rodriguez, G. and Gomez-Mejia, L.R. (2012) Towards a social attempt to solve these problems through contractual arrangements, incentives or the terms of e.g. building a promotion case; and b) when clients are not interested in a theory of agency. Journal of Management Studies, 49 (1), pp. 202-222 appropriate governance, which should reduce the agency problems (Joslin and Muller, sustainable and fair relationship with their contractors, but either aim to deploy the project with minimal budget and effort disregarding the impact this might have on the 2016). Agency theory differentiates between two types of contracts (Florical and Lampel, contractors or also follow their personal interests like securing a bonus for achieving 1998): the outcome-based contract, of which a fixed-price contract is a typical example, and DISCUSSION QUESTIONS certain not-project related KPIs. the behavior-based contract, of which a fee-for-service contract is a typical example. Agency theory argues, that the agent will be more likely to act in the interest of the principal if the 1. Which agency related issues can you identify in the case? Degree of opportunistic behavior - This can also be observed in the adversarial and contract is outcome-based as the reward for both depends on the same actions and hence, 2. How were the different issues addressed by Steven and Mark? fragmented project environment as it relates to the maximization of economic self- the goal conflict and likelihood of opportunistic behavior are reduced (Eisenhardt, 1989) 3. Do you think the way Steven and Mark addressed the agency related issues was interest in particular when a situation occurs which can be exploited. This is often the However, if appropriate information systems are in place, which put the principal in the appropriate and effective? Why? case when one party is in a difficult situation and requires support and the other party position to verify the contractor's performance and behavior, behavior-based contracts can tries to get the most out of the situation for themselves, e.g. if the project is delayed, 4. Can you relate mechanisms to resolve agency related issues in this case to some of be appropriate (ibid). Next to the type of contract, the contractual completeness is another the mechanisms identified in the CURED framework (see Bryde et al, in press)? What but the client requires a certain completion date, the contractor might overprice factor, which can contribute to the reduction of agency-related issues, whereas contractual does this tell us about Steven's and Mark's approach? acceleration measures and hence exploit the client