Study on Added-Value Sharing Ratio of Large EPC Hydropower Project Based on Target Cost Contract: A Perspective from China

Abstract

Engineering, procurement, and construction (EPC) has been applied in China’s hydropower projects for its value-added advantages compared with traditional project delivery systems in theory. However, the actual performance of large EPC hydropower projects has been challenged by the complexity of the stakeholders’ interest demands and conflicts. The increasing use of target cost contracts (TCC) in the construction industry has provided a pain/gain share mechanism for the owners to incentivize contractors to complete projects within cost budgets. The added-value sharing ratio is the core element of TCC, and it predetermines how much proportion of savings the contractor can get paid if the actual cost is below the target cost, and how much proportion of overspend the contractor has to pay if the actual cost is higher than the target cost. In this paper, we consider the added-value sharing ratio under the framework of TCC based on the principal-agent theory, and look at how the added-value sharing ratio is influenced by various factors and how it affects the owner and the contractor in large EPC hydropower projects. Determination of the added-value sharing ratio in both discrete and continuous conditions are discussed, respectively. It is found that the added-value sharing ratio is relatively explicit in the discrete case, while the optimal added-value sharing model in the continuous case is more complex, which can be used to analyze the relationship between the added-value sharing ratio and the key influencing factors. Our research conclusions can provide both theoretical guidance and practical suggestions to contract design in the implementation of EPC hydropower projects, to some extent.