An Economic Analysis on Risk Sharing, Incentivization, and Defense Procurement Contract Design in the Maor Defense Acquitition Program Setting

Abstract

The purpose of this study is to develop a theory-based framework linking program risk, contractor behavior, and contract type selection to combat information asymmetry that contributes to cost overruns, slipping timelines, and underperformance relative to initial expectations in Major Defense Acquisition Programs (MDAPs). This thesis aims to answer: What is the optimal contract structure for achieving effective risk-sharing and incentivizing performance in MDAPs? Theoretical modeling and mathematical simulation are used to analyze and solve these issues and provide acquisition professionals with a practical tool to combat information asymmetry when contracting for developmental efforts of MDAPs. The research concludes that a dynamic, risk-adaptive incentive model that evolves with program maturity is most effective in combating asymmetric information. Specifically, modifying the standard cost-plus-incentive-fee (CPIF) structure where target profit and share-ratio are variables of target cost was found to be most effective when technical risk and uncertainty are high. This study recommends integrating mechanism-based analysis into defense contracting to enhance MDAP acquisition strategies. This thesis recommends implementing the Budget Based Cost-Plus Incentive Scheme (BBCPS) incentive mechanism for developmental efforts of MDAPs. The BBCPS modifies the standard CPIF incentive in a smart way to align the objectives of offerors and contractors with the government.