Option Pricing Model to Analyze Cost–Benefit Trade-Offs of ADR Investments in AEC Projects
Publication: Journal of Construction Engineering and Management
Volume 135, Issue 3
Abstract
Alternative dispute resolution (ADR) techniques are adopted by architecture, engineering, and construction project participants to help achieve reasonable settlement of claims and change orders (CCOs) that arise during a project’s life cycle without having to resort to protracted litigation for final determination of merit. Since such ADR techniques require resources to prepare, review, and resolve CCOs, the managerial decisions regarding the investments for these resources need to be economically justified. The application of the net present value approach to determine the value of any ADR investment is limited because the future cash flows resulting from such an investment cannot be estimated a priori as they will vary with the nature of the CCOs, the amounts claimed, and the effectiveness of the ADR in addressing these CCOs. This paper presents a conceptual and mathematical model to evaluate ADR investments by drawing an analogy from theories of financial and real option pricing. The objective is to provide the owner with a decision framework that accounts for the uncertainty in estimating the ADR investment cash flows during the project planning phase, and provides realistic results regarding the value of this investment. The model presented in this paper is applied to a real case study involving a seismic retrofit of a bridge project to demonstrate the parameter estimation and the practical application of the model.
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Acknowledgments
The writers would like to acknowledge the financial support for this research received from National Science Foundation CAREER and PECASE Award CMS-9875557 and Award CMS-0324501. The writers also would like to thank Professor Carlos A. Arboleda of the University of Illinois at Urbana–Champaign for his helpful comments on drafts of this Paper. In addition, the writers would like to acknowledge the support of the late Mr. Lawrence Delmore from the Dispute Review Board Foundation; Ms. Carolyn Lynch from the United States Army Corps of Engineers; Ms. Warnecke Miller from the United States Air Force; Mr. Michael Kissel, Mr. Henry Wells, Mr. Reza Hajjari from the California Department of Transportation; and Mr. Mark Wright from the Florida Department of Transportation for providing data and helpful insights on partnering and dispute review boards. In addition, the writers would like to acknowledge the sincere efforts of undergraduate research students, Mr. Michael Addison and Mr. Allen Barton, at the University of Illinois, Urbana–Champaign, for their help in obtaining conflict resolution data. Any opinions, findings, and conclusions or recommendations expressed in this paper are those of the writers and do not reflect necessarily the views of the organizations or the individuals mentioned here.
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Information & Authors
Information
Published In
Journal of Construction Engineering and Management
Volume 135 • Issue 3 • March 2009
Pages: 156 - 168
Copyright
© 2009 ASCE.
History
Received: Jul 9, 2007
Accepted: Sep 9, 2008
Published online: Mar 1, 2009
Published in print: Mar 2009
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