Chapter 4: Asymmetric Information: The Big Barrier to Change

The doctrine of caveat emptor (buyer beware) has lost much of its force in recent decades, and it is not clear why it should be upheld in construction, where information asymmetries are so large. Other markets characterized by high levels of asymmetric information-legal advice, finance, medicine, education-are highly regulated, professionalized, and/or intermediated, in large part to protect consumers from unscrupulous producers. There is no reason why property owners who contract to build buildings for millions of dollars should be held to a higher standard than purchasers of other complex, big-ticket, customizable services. There is no doubt that asymmetric information leads to mutable cost contracting. But it also creates a host of other problems that stem from the resulting lack of effective competition in construction: weak and short-sighted management, inadequate education of industry professionals and meager investment in research and development.

Markets run best when both buyer and seller have equal access to information, but in the construction industry, they do not. For a number of reasons peculiar to construction, building owners cannot easily compare building price or quality-at the start, during construction, or even after the job is done. In most instances, the construction team pre-sets the project budget by reviewing the design documents prepared by the architect and the engineers. There is rarely anyone equally knowledgeable about material or labor costs to effectively challenge the budget set by the contractor. Most inexperienced owners cannot readily distinguish between reasonable and unreasonable contractor bids. Even when they can, their only real alternative if the price comes in higher than the project budget is to reduce or eliminate features since the contractor will be unlikely to reduce its overall price without a commensurate scope reduction. Even then, the contractor will maintain the same degree of profitability.

Moreover, sundry difficulties-real or imagined-can necessitate numerous change orders, which are always presented after any real threat of competition has passed. As construction economist Patricia Hillebrandt explains, "The monopoly power of the negotiating contractor will be greater, the greater the time and money already invested by the client in these negotiations."

Ineffective Intermediaries

Traditionally, architects acted on behalf of owners to mitigate predatory contractor behavior, but increasingly they have shown themselves unsuited to the task. In the 1970s the American Institute of Architects aided the retreat by revising its standard form agreements to reduce the architect's scope of services during the construction phase from "full time" onsite availability where it "oversaw" the construction to "periodic" site availability where it simply "observed" the construction.

Into this vacuum the construction manager rode, selling new services to owners in the face of the architects' retreat. While ostensibly acting in the interest of their new owner clients, these construction managers were, as many industry insiders say, simply contractors with suits and ties. With no true intermediary protecting owners, predatory change orders became common. Without a knowledgeable intermediary to serve its interests, the owner was now in a predicament: the sole party with the knowledge of construction costs was the same party who was in charge of construction. The competitive bidding process now merely allowed the owner to choose his poison: general contractor fixed price or construction manager guaranteed maximum price. With either one, the end result was likely to be the same.

CHAPTERS  INTRODUCTION  1  2  3  4  5  6  7

 

  ©2007 Barry B. LePatner. All rights reserved. Disclaimer.