On Optimal Risk and Benefit Sharing in Engineering Projects.


Nieto-Cerezo, O (2017) On Optimal Risk and Benefit Sharing in Engineering Projects. PhD thesis, University of Liverpool.

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Abstract

This thesis applies agency theory to design risk regulatory policies in the implementation of sustainable sea defences. The aim is to investigate methods to reduce the probability of an accident inflicted on the society by resolving a downstream and an upstream moral hazard problem existing in engineering problems with an emphasis on the construction of sustainable sea defences. The risk regulation aims at reducing the probability of damage cost associated with flooding by enhancing an operator's safety operational procedures. It is defined by three policies; a safety design, a transfer payment, and a fine. In the downstream moral hazard between an operator and a regulator, a risk neutral operator under full liability will implement a sea defence which is optimal from the regulator's point of view when a fine is set equal to damage cost without a cost for the regulator. However, if the operator has limited assets to cover the damage cost, a cap on the operator's fine is placed to take into account that an operator may default if damage costs are too high. Limiting the responsibility of the operator in case of an accident decreases the strength of the incentive mechanism leading to the implementation of a sea defence below the socially optimum. This second best height of the sea defence involves an informational cost to the society in the form of a liability rent to guarantee the participation of the operator in the engineering project. The more we make the operator liable for the damage cost, the higher the liability rent. The society faces a trade off between liability rent and residual risk. The higher the residual risk, the lower the liability rent. Unlike the limited liability case, an operator with averse attitude to uncertain payoffs will implement a sea defence higher than a risk neutral operator in order to reduce the weight on the upper extreme values of the tail of the fine. This is because the marginal fine decreases under risk aversion. Similarly to the limited liability case, the implementation of a second best height of the sea defence is not free for the society. The society will have to compensate the operator for participating in the project in the presence of uncertain payoffs. This compensation takes the form of a risk premium and is subject to the risk coefficient and the variance of the damage cost distribution. Due to the lack of regulatory quality and independence, a pro-industry regulator and a government may have conflicting interest about the fine cap to impose to the operator. While the regulator prefers a higher fine cap to induce a higher liability rent, the government seeks to impose a lower fine cap. The government faces a trade off problem between how much discretion should be given up and how much expert information should be used from the regulator. In the case when the government observes that any of the fine cap choices available to the regulator is higher than its ex-ante choice of the fine cap, no discretion will be granted because the cost to the society outweighs the benefits of using the regulator's expertise. Nevertheless, when the government observes that some of the fine cap choices available to the regulator are lower than its ex-ante choice of the fine cap some level of discretion can be granted. The limit on the fine caps that the regulator can announce is determined by how much the regulator is biased towards the interests of the nuclear industry. When the regulator's range of fine caps is optimally restricted, the objectives of the regulator and the operator will be aligned by encouraging the regulator to choose a fine cap that will not exceed the optimal fine cap of the government.

Item Type: Thesis (PhD)
Divisions: Faculty of Science and Engineering > School of Engineering
Depositing User: Symplectic Admin
Date Deposited: 24 Aug 2017 08:45
Last Modified: 19 Jan 2023 07:00
DOI: 10.17638/03008288
Supervisors:
URI: https://livrepository.liverpool.ac.uk/id/eprint/3008288
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