Article

Construction Surety Bonding

Authors:
To read the full-text of this research, you can request a copy directly from the authors.

Abstract

The qualification process in the construction bond business is very complicated, labor-intensive, and time-consuming. The construction bond underwriting processes contain subjective judgments that require human involvement to reach decisions. Thus, underwriting evaluations are bound to be very difficult, ambiguous, and have potentially great losses. This paper identifies and classifies quantitative and qualitative risk factors impacting construction bond underwriting, to improve the quality of the evaluation analysis and to reduce the highly unstructured environment and the subjectivity of the bond evaluation in underwriting. The methodology provides a systematic information analysis for the heuristic knowledge of the construction surety bonds underwriting process, provides better control over the risk assessment process by providing independent judgments for the major decision factors and an overall judgment for the final contractor's risk assessment decision, and reduces the time and effort required of the current evaluation process to reach a certain decision and to simplify the complicated nature of this process.

No full-text available

Request Full-text Paper PDF

To read the full-text of this research,
you can request a copy directly from the authors.

... In the context of this study, the principal is the contractor, while oblige is the client of construction projects. Although the underwriting process of surety bonding is considered as a line of insurance, Kangari and Bakheet (2001) observed that it has many similar characteristics to a bank lending process because the applicant is being judged from the credit risk perspective. The surety does not lend money to the contractor, but it is committing its financial resources to guarantee contractor's performance and to ensure that the contractor will pay labourers, material suppliers and sub-contractors. ...
... To secure the bond, Oke et al. (2015) noted that there are basic elements that are considered by the guarantors to determine the suitability of the contractors. Kangari and Bakheet (2001) summarised the factors impacting bond evaluation into four major areas that are financial strength of the contractor, past experience, contractor's capacity and contractor's continuity. An evaluation form was developed based on each of the identified factors, while 70 subfactors were also identified. ...
... In producing a scoring system for construction bond underwriting, Mehmet and Makarand (2010) classified the necessary scorecard characteristics and attributes into character, capacity, capital and continuity; this is known as the 4Cs of bonding. There are similarities in the classifications by Kangari and Bakheet (2001), Mehmet and Makarand (2010) and Powelson (2007) except for minor differences. Financial strength of contractor is the capital, while past experience is related to the character. ...
Article
Purpose The ability of construction contractors to engage in construction bond agreement with guarantors depends on capital, experience, capacity and continuity. Using these criteria, the purpose of this paper is to provide insights into the bonding capacity of Nigerian contractors. Design/methodology/approach Factors required for bonding were examined based on a set of questions addressed to managers of contracting firms and personnel involved in issuing bonds and guarantees in commercial banks and insurance companies. The scorecard approach was employed to determine the bonding capability of the contractors. Findings Contractors’ financial strength and past performance on previous projects are the two important factors considered by guarantors in granting bond to contractors. However, the condition surrounding the bond, the legal capacity of the guarantor to issue bond and the identity of the guarantor are mostly considered by contractors in approaching a potential guarantor. Using the scorecard approach, about one-third of contractors have the necessary requirements to engage in construction bond agreement with guarantors. This ability of contractors is affected by years of experience of the firm but not by their location nor years of experience of their manager. Practical implications It is necessary for contracting firms to increase their capital base through merging, borrowing, etc., and also engage experienced professionals and workers in the execution of construction projects, as this will eventually improve their bonding ability. Social implications The study is limited to construction contractors registered with Ondo and Lagos State Governments and guarantors that are banks and insurance companies in Nigeria. Originality/value The paper specified various areas of concerns for Nigerian contracting firms in their bid to enhance their bonding ability. This will help them in overcoming various challenges and bottlenecks that may arise in securing bonds and guarantees from guarantors.
... In a study on construction surety bonding. Kangari and Bakheet (2001) observed that a contract bond guarantees the construction contract and all its provision in which the prime contractor accepts two responsibilities which are: to perform the objective of the contract; and to pay all costs associated with the work. In the Chinese construction industry, Xianhai (2002) concluded that there has been a significant tendency for the default risk to increase in recent years and establishing a construction contract guarantee system therefore becomes a necessary choice to make both contractors and owners honour contracts and act in good faith. ...
... Surety bonds existed long ago when it was simply an honest hand shake between two or more parties. The parties agreed to a decision and gave their personal guarantees of following through by completing all work (Kangari and Bakheet, 2001). Construction bonds are effective tools for ensuring successful construction projects (Boswall, 2010). ...
... There are four ways of addressing risks in construction and they are: Risk transfer, risk sharing; risk acceptance and acting as if there is no risk (laissez-faire). In the US., Surety Information Office (2009) noted that construction bond is a risk transfer mechanisms regulated by state insurance departments Kangari and Bakheet (2001) observed that a surety bond is a risk transfer mechanism that shifts the risk of contract default from the project owner to the surety. It further classified quantitative and qualitative risk factors impacting construction bond underwriting, to improve the quality of the evaluation analysis and to reduce the highly unstructured environment and the subjectivity of the bond evaluation in underwriting. ...
Conference Paper
Full-text available
Construction bond was introduced as an instrument to protect or indemnify its recipients against risks and problems associated with construction projects but the challenge over the years lies in the practical enforcement of bonding conditions and its overall benefits to the construction industry. This research therefore examined risks and problems inherent in bonded and unbonded projects with a view to ascertaining their effects on overall construction projects success. Primary data were collected through administration of questionnaires on identified construction bond stakeholders namely: clients of public projects: quantity surveying and architectural firms; contracting firms; and guarantors of construction bonds (banks and insurance companies). Questionnaires were administered on 337 respondents out of which 242 were returned while 236 were certified fit for analysis. Mean item score was used for ranking the identified factors while Kruskal-Wallis and Mann-Whitney tests were employed to examine relationship and differences in sample means of different groups of respondents respectively. The study revealed that financial soundness of the issuer commonly referred to as credit risk has major effect on projects with bond while for projects without bond, liquidity risk required the most attention. However, there is no significance difference on the effect of bond risks on project with and without bond. Since the identified risks are mainly for bonded projects, there is therefore a need to implement usage of bonds for all forms of projects to reduce risks to the barest minimum.
... Jack, Simon, and Phil (2006) believed that the costs to an employer following the failure of a contractor during the course of a project can be significant whereas, Al-Sobiei, Arditi and Polat (2005) observed that client tend to pass the responsibility of project risks to the contractor via contract bonds to deal with the risk of contractor default. According to Kangari and Bakheet (2001), a construction surety bond is a financial instrument used generally when the first party (owner) has an agreement with a second party (Construction Company). This financial instrument serves as a guarantee to the first party from a third party (Surety Company) that a construction job (obligation) will be completed according to the terms and conditions within a written contract. ...
... Construction bond was introduced as an instrument to protect or indemnify its recipients against such negative occurrence but the problem lies in the practical enforcement of bonding conditions and its overall benefits to the construction industry. Kangari and Bakheet (2001) concluded that construction surety industry is undergoing serious problems and most of them are suffering financial looses. More so, Australian ...
... In the administration of construction bonds, it is worthy of note that the following problems still persist (Adegboye, 2004;Boswall, 2010;Kangari and Bakheet, 2001;Loosemore, 2006;Mehmet et al., 2006;Ojo, 2011): client most times insist on contractors securing bonds from a specified guarantor and such guarantor may not be easily accessible by the contractor; inability of contractors to secure required bond from the guarantor within appropriate period; conditions surrounding the bonds not fully read and understood by the stakeholders; guarantors' requirement for bonding is sometimes beyond the capacity of the contractors; contractors not discharged/released by client as at when due and appropriately; different approaches to administration of construction bond in various countries; dispute and claims as a result of unsuccessful bond administration; and unsuccessful bond administration affecting the overall project success in term of cost, time and quality. Against this backdrop, this study is designed to address the administration of bond in Nigerian construction industry with a view to providing necessary and appropriate guidelines for effective usage of bonds by stakeholders in the industry. ...
Thesis
Full-text available
Construction works are plagued by diverse risks and problems such as project abandonment, building collapse, contractor insolvency, projects failure, among others. One of the risk management practices in combating these issues in construction projects is the use of construction bonds. This research therefore examined the administration of these bonds with a view to ascertaining their effects on overall construction projects success, thereby providing relevant empirical information for stakeholders for effective administration of construction bond. Primary data were collected through administration of questionnaires on identified construction bond stakeholders namely: clients of public projects: quantity surveying and architectural firms; contracting firms; and guarantors of construction bonds (banks and insurance companies). Interviews were also conducted on experienced respondents and it was ensured that each of the group of stakeholders were represented. In addition, historical quantitative data of completed bonded public/government projects were also obtained. Mean item score was used for ranking the identified factors while Pearson's moment of correlation, Kruskal-Wallis and Mann-Whitney tests were employed to examine relationship and differences in sample means of different groups of respondents respectively. Iteration of regression equation was used to examine relationship between construction bond administration and project delivery indices while structural equation model was applied in developing framework for administration of construction bonds. The study revealed that despite the high importance attached to usage of construction bonds, some of the stakeholders were not fully aware of it and its level of usage for construction projects was on the average. It was also observed that identified problems of construction projects were more inherent in projects that are not bonded. Construction bond guarantors have the greatest effect on bond administration compared to other stakeholders and only about two-third of the contractors have the character, capacity and capital to be part of construction bond agreement. It was also discovered that construction bond administration contributed about 78% to success of construction projects. The study therefore recommended the need to adopt the use of construction bonds for all forms of projects either public or private as against the current practice where it is only mandated for public projects. In addition, in an open circumstance where insurance and bank bonds are acceptable, it is expedient to encourage contracting firms, clients and other construction bond stakeholders to see insurance companies as their first point of call while seeking for bond guarantor as a result of their low interest rate.
... Kangari and Bakheed [40] identiied and classiied quantitative and qualitative risk factors that impact construction bond underwriting, to improve the quality of the evaluation analysis and to reduce the highly unstructured environment and the subjectivity of the bond evaluation in underwriting. The objective of their paper was, based on a set of surveys and interviews with surety companies, to identify major factors impact surety-bond evaluation. ...
... The second one was contractors past experience or character atributes such as the quality of contractor's people and their experience, contractors past work, contractor's business plan and trust with agents. Contractor's capacity, work schedule to analyze job's consistency and potential project characteristics; and contractor's continuity that came as the least important factor among the others [40]. ...
Chapter
Full-text available
... One of the ways of managing issues and conflicts arising from construction works is the use of bonds. According to [3], a construction surety bond is a financial instrument used generally when the first party (owner) has an agreement with a second party (Construction Company). This financial instrument serves as a guarantee to the first party from a third party (Surety Company) that a construction job (obligation) will be completed according to the terms and conditions within a written contract. ...
... In a study on the purposes and implication of performance bond, [4] concluded that in the construction context, back-up or guarantor or surety or the third party is likely to come from one of these two sources: Parent Company Guarantee that has to do with the contractual performance of one company within a corporate group is underwritten by other members of the group; or Bonds, which is normally provided (at a price) by a financial institution such as a bank or an insurance company. [3] concluded that construction surety industry is undergoing serious problems and most of them are suffering financial looses. This study therefore examined proneness of construction projects executed with and without bonds and guarantee to constructions risks and problems. ...
Conference Paper
Full-text available
Construction bond was introduced to enhance performance of construction projects by protecting or indemnifying its recipients against projects' risks and problems, but the challenge over the years lies in the practical enforcement of bonding conditions and its overall benefits to the construction industry. This research therefore examined risks and problems inherent in projects with and without bonds, with a view to ascertaining their effects on construction projects sustainability. Primary data were collected through administration of questionnaires on identified construction bond stakeholders namely: clients of public projects: quantity surveying and architectural firms; and contracting firms. Questionnaires were administered on 337 respondents out of which 242 were returned while 236 were certified fit for analysis. Mean item score was used for ranking the identified factors while Kruskal-Wallis and Mann-Whitney tests were employed to examine relationship and differences in sample means of different groups of respondents respectively. Despite the high importance attached to usage of construction bonds, the study revealed that projects executed without these bonds and guarantee are more susceptible to problems and risk which can emanate during or after construction of projects. It also revealed that sustainable construction can be achieved through the use of bonds and guarantees. The study therefore recommended the need to adopt the use of construction bonds for all forms of projects either public or private as against the current practice where it is only mandated for public projects.
... A bond is a formal contract to repay borrowed money with interest at fixed intervals, Emily (2009) asserted that Construction bonding is a risk management tool used to protect project owners and developers. Kangari and Bakheet (2001) asserted that the Surety Association of America (SAA) has defined a surety bond as, an agreement providing for monetary compensation should there be a failure to perform specified acts within a stated period. A surety bond is a risk transfer mechanism that shifts the risk of contract default from the project owner to the surety. ...
... A bond might be sold at above or below par (the amount paid out at maturity), but the market price will approach par value as the bond approaches maturity. Kangari and Bakheet (2001) asserted that the qualification process in the construction bond business is very complicated, labour-intensive, and time-consuming. In finance, a bond is a debt security, in which the authorized issuer owes the holders a debt and, depending on the terms of the bond, is obliged to pay interest (the coupon) and/or to repay the principal at a later date, termed maturity. ...
Conference Paper
Full-text available
Advance Payment Bond is a written statement given by the contractor that he will repay or settle the advanced money paid by the owner related to contract. This research assesses the benefits and performance of advance payment bond in the Nigerian construction industries using survey method. Questionnaires structured to address the aim of the research were administered on pre-qualified and registered contractors, architects and quantity surveying firms. Forty-seven (47) of the administered questionnaires were retrieved. The findings from the study showed that contractual method which prompts the decision to provide advance payment bond is mainly ones with target cost contract while procurement methods which prompts the decision to provide advance payment bond are mainly design and build, design and contract, management contracting, and fast track procurement options. Relationship between advance payment bond (using cost of bond, cost of securing bond and time taken to secure bond) and construction project delivery indices (cost overrun, time overrun, final cost of projects and final duration of projects) was also established. The study recommended that there is a need for good and proper understanding of the concept of advance payment bond by both the contractors, consultants and the clients/owner/sponsors.
... Boswell (2010) defined construction bond as a written agreement in which one party (the surety) guarantees that a second party (the principal) will fulfil its obligations to a third party (the oblige). Although the underwriting process of surety bonding is considered as a line of insurance, it has many similar characteristics to a bank lending process because the applicant in either case is being judged as a credit risk (Kangari and Bakheet, 2001). The surety does not lend money to the contractor, but it is committing its financial resources to guarantee a contractor's performance and to ensure that the contractor will pay labourers, material suppliers, and subcontractors. ...
Conference Paper
Full-text available
Issues such as project abandonment, non-performance of contractors, failure to deliver construction projects to cost, time and quality, etc. are peculiar to the built environment in developing nations like Nigeria In order to enhance responsive built environment, several means of minimising these challenges have been proposed. One approach is the use of construction bonds. This paper is a report of a pilot study carried out to gain a general overview of the usage, importance and administration of construction bonds in Nigeria. While conducting the study, each of the group of construction bond stakeholders contractors, consultants, clients and guarantors were contacted as deemed appropriate using convenience sampling method. To ensure uniformity, 4 questionnaires each were administered on each group of respondents resulting in a total of 16. On the average, the respondents have about 11 years of experience and have worked on about 15 construction projects out of which about 7 are bonded - representing about 43% of construction projects. Emerging from the study is that banks were preferred over insurance companies for issuance of construction bonds while advance payment bond were mostly used among the four types of construction bonds involved. Tendering method has the greatest effect on construction bond administration compared to other project characteristics, while guarantors had the most significant contribution compared to other stakeholders. The study also revealed that bonds ensure that contractors comply with conditions of contract and also help to indemnify clients against default. Moreover, construction risks and problems were more inherent in construction projects that were not bonded. As such, it is expedient to ensure that large construction projects are bonded regardless of the type of client and size of the project.
... For future studies, an in-depth analysis of the proposed framework from all parties' perspective is still recommended. The rich literature around performance bond (Kangari and Bakheet 2001, Bayraktar and Hastak 2010, Awad and Fayek 2012 support system for prequalification and pricing premium of the green performance bond. For this purpose, game theoretic analysis (Asgari et al 2013) and agent-based models (Awwad et al 2014) can be employed to simulate the interaction among all parties and find the long-term benefits and implications of green performance bonds on the industry. ...
Conference Paper
Full-text available
With growing concern about global warming and climate change, the construction industry, as a major contributor to greenhouse gas (GHG) emissions, has begun to realize its essential role in improving the environment by reducing emissions through the life cycle of buildings and infrastructure. While a considerable amount of prior research has been devoted to assess the environmental impacts of sustainable design alternatives and post-construction operations, there is an increased awareness of, and demand for, managing greenhouse gas (GHG) emissions during the construction stage. One approach suggested by previous researchers is to adopt an innovative competitive bidding system which includes the estimated environmental cost incurred during the construction phase as one of the evaluation criteria in addition to cost and schedule. The main problem with this practice, however, is that there are no enforcement mechanisms to guarantee the performance of GHG emissions. As a result, it may induce contractor’s opportunistic bidding behavior which could lead to many issues such as abnormal low bids and poor environmental performance. To address the problem, this research proposed a framework which adds another dimension to the traditional project management structure and investigates the possibility of applying a green performance bond to insure against the risk of discrepancy between the actual and expected performance of GHG emissions during construction. Drawing an analogy from the construction performance bond, a conceptual model is presented to illustrate how to utilize this innovative surety product to manage embodied carbon in the construction stage.
... In the 1890s, the idea of surety emerged when it was presented by individuals or groups such as Lloyd's of London (Russell, 2000). American Surety Company was the first company to issue surety bonds for construction contracts in 1887 (Kangari & Bakheet, 2001). Industries such as hard rock and coal mining, oil and gas industries are among the sectors that need surety as required by legislation (Kirschner & Grandy, 2003). ...
... In the administration of construction bonds, it is worthy of note that the following problems still persist (Adegboye 2004;Boswall 2010;Kangari and Bakheet 2001;Loosemore 2006;Mehmet et al. 2006;Ojo 2011): most times, the client insists on contractors securing bonds from a specified guarantor and such guarantor may not be easily accessible by the contractor; inability of contractors to secure the required bond from the guarantor within the appropriate period; conditions surrounding the bonds not fully read and understood by stakeholders; guarantors' requirements for bonding are sometimes beyond the capacity of the contractors; contractors not discharged/ released by the client as at when due and appropriately; different approaches to administration of construction bond in various countries; dispute and claims as a result of unsuccessful bond administration; and unsuccessful bond administration affecting the overall project success in terms of cost, time and quality. Against this backdrop, this study is designed to examine the effect of administration of bond on success of construction projects. ...
Article
Full-text available
Construction bond administration involves management of bond issues from inception of obtaining bond from guarantor to the point of release of contractor by the client. This process has posted a lot of challenges to construction stakeholders; it is therefore, necessary to examine the relationship between bond administration and project success. Archival data of completed bonded building projects were gathered through a pro forma developed for this purpose. Using Pearson product moment of correlation, it was revealed that the cost of securing a construction bond has a positive and significant effect on the initial and final costs of the project, while the number of days needed to secure a construction bond has no significant effect on the initial and final durations of the construction project. In order to establish the relationship between project delivery indices of cost and time and the construction bond administration variables, iteration of linear regression was adopted to arrive at the best-fit equation. Factors affecting the cost of securing construction bonds from guarantors should be identified and given adequate attention by construction stakeholders in order to minimize the effect of construction bond administration on project delivery.
... İngiltere'de 16. yüzyıldan itibaren kurumsal kefalet şirketleri kurulmaya başlamış olsa da (Gözüşirin, 2014a) asıl uygulamalar ABD'de gelişmiştir. 1884 yılında kurulan the American Surety Company, 1887 yılında inşaat sözleşmelerine ilişkin kefalet senedi sigorta poliçesi düzenleyen ilk şirket olmuştur (Kangari & Bakheet, 2001). The Guarantee Society of London isimli ilk kefalet şirketinin ise ABD'den 20 yıl önce İngiltere'de faaliyete geçmesini Morgan (1926), diğer sebepler arasında; ekonomik kalkınmada ABD'nin daha geride olması, tarıma dayalı yeni bir ülke olması ve endüstri ile finansı birleştirecek bu tür kurumlara ihtiyaç duyulmamasını sebep olarak göstermektedir. ...
Article
Full-text available
Borçlunun, bir sözleşme veya kanundan doğan yükümlülüğünü ye-rine getirmeme riskine karşı teminat sağlayan finansal ürünlerden biri de kefalet sigortasıdır. Birçok kullanımına ek olarak, kefalet sigortası-nın proje finansmanında da teminat mektupları gibi kullanımı mümkün olmaktadır. Ülkemizde yasal altyapısı uygun hale getirilmiş ve teminat türleri tanımlanmış olan bu ürünün uygulaması ve muhtemel etkileri Türk finansal kesimi için önem arz etmektedir. Başta bankacılık sektörü olmak üzere ilgili tüm paydaşlara etkisi olacak bu yeni ürünün değerlendirilme-si çalışmanın bir bölümünü oluşturmaktadır. Kefalet Sigortası'nın yeni bir ürün olarak değerlendirilmesi; rakip, alternatif veya tamamlayıcı sayıla-bilecek mevcut ürünlerle karşılaştırılarak Türk finansal sistemine sağla-yacağı olumlu ve olumsuz katkıların tartışılması çalışmanın temel amacı olarak ortaya çıkmaktadır.
... Liquidity can be determined through accounts receivable turnover, accounts payable turnover, current ratio and the working capital to backlog ratio (Kangari and Bakheet 2001). By comparing the trend of profitability with and without bonding constraints, Cui (2005) concluded that the bonding capacity constraints move the profitability downwards. ...
Article
Full-text available
Expected long-term growth of organizations is path dependent and hinged to a series of decisions. In project-based industries, this path is shaped by decisions such as project selection. In this paper, we aim to explore the hypothesis that decisions regarding project selection are dynamic in nature, and the sequential strategies of organizations can have a butterfly effect on their long-term growth. For this purpose, we explored different project selection strategies based on the payback period of projects and their profitability, and considering capacity of the organizations. A real case study based on a midsize construction company in the United States is then used to showcase the application of the model to develop strategies for the long-term growth of organizations. Theoretically and thematically, the proposed simulation suggests that the emergent long-term impact of project selection strategies can be added to considerations in portfolio management to develop more informed long-term strategies.
... Bonds is a tripartite agreement between the surety, the project owner, and the contractor on the project. Kangari and Bakheet (2001) opined that even though the underwriting process of surety bonding is considered as a line of insurance; ...
Article
Full-text available
Default by contractors in meeting the time and cost performance of a project is usually counterproductive. Considering safety from the high financial burden of construction projects, clients are compelled to seek a level of guarantee in bonds to safeguard them from financial problems and provide incentive for proper and timely completion of the project by the contractor, thereby minimising failures and risks. Therefore, the study assessed the level of bond utilization in Nigerian construction industry, with a view to examining the benefits of its utilisation in construction projects. Survey method was adopted in which questionnaires were used to collect data from respondents. With a response rate of 45.30% (164 of 362), the collected data were analysed using descriptive and analytical scientific method. It was found that the level of bond utilisation in construction contract is high, with performance bond and Advance payment bond being most commonly used construction bond types. Assurance of performance and financial security are the major benefits of bond utilisation. The study recommends that there is need for more enlightenment of construction participants on the various types bond used in construction contracts
... Bonds is a tripartite agreement between the surety, the project owner, and the contractor on the project. Kangari and Bakheet (2001) opined that even though the underwriting process of surety bonding is considered as a line of insurance; ...
Article
Full-text available
The purpose of the study is to substantiate the feasibility of using the theory of chaos in the process of managing the industrial enterprises. One of the tools for managing chaos is proposed to be chaos engineering – a method of conducting planned experiments that give an idea of how the system can behave as a result of disturbances. The introduction of chaos engineering will allow for prediction of possible perturbations and prepare the system for a new attractor at an optimal time with minimal losses. The chaos management model of the economic system, which allows either a radical change in the status of the enterprise, its ability to influence demand and supply while maintaining the subjectivity of the development, or to promote antifragility of the enterprise, allows strengthening the stability of the economic system.
... financial strength, past experience, business plan, work capacity, quality and experience of the technical personnel, etc.), and project characteristics (i.e. work schedule, type, value, duration, complexity, location of project, contract type and variation between the contractor's bid price and the next lowest bidder's price, etc.) (Russell, 1990(Russell, , 1991(Russell, , 1992Kangari and Bakheet, 2001). ...
Article
Full-text available
The construction project is subject to several risks, one of the most important of which is contractor default because contractor default may increase the final project cost considerably. In the US construction industry, owners commonly shield themselves from the risk of contractor default by transferring this risk to the contractor, who in turn transfers this risk to a surety company. On the other hand, the General Directorate of Military Works (GDMW) of the Kingdom of Saudi Arabia retains the risk of contractor default rather than transferring it to a third party. An artificial neural network (ANN) and a genetic algorithm (GA) are used in this study to predict the risk of contractor default in construction projects undertaken for the Saudi armed forces. Based on this prediction, the Saudi GDMW can make a decision to engage or not to engage the services of a contractor. In case the models are not able to generate reliable predictions (or generate contradictory outcomes), the GDMW will have to augment its budget with contingency funds to be used in the event of contractor default. The outcome of this study is of particular relevance to construction owners because it proposes an approach that can allow them to replace an indiscriminate blanket policy by a policy that is rational, effective, prudent and economical.
... A surety bond is introduced as a risk transfer instrument to protect the owners from the unexpected default behavior of contractors [19,20] and promotes the sustainability of construction markets. There are mainly two kinds of surety bond, the low-penalty unconditional bond (on-demand bond) and ...
Article
Full-text available
In construction projects, some contractors will take default actions against the contracts to obtain maximum profits and damage the owners’ benefits as a result. In the construction markets where effective supervision is not performed well, contractors have more opportunities to default. Surety bonds were designed to solve the default problems and promote the sustainable development of the construction markets. This paper was proposed to explore the interactions between owners and contractors and investigate the influence of surety bonds (high penalty and low penalty) on the default behavior of contractors based on a static and dynamic evolutionary game analysis model. The results showed that applying the surety bond strategy is effective at decreasing the probability of the contractors’ default behavior when the credit system based on a surety bond system is well developed in the construction industry and the cost of the surety bond is low enough. Therefore, government strategies such as a better development of the credit system driven by surety bonds and the subsidies on surety bonds to reduce the cost can mitigate the contractors’ default behavior and keep the sustainability of the construction markets.
Article
The financial health of construction contractors is critical in successfully completing a project, and thus default prediction is highly concerned by owners and other stakeholders. In other industries many previous studies employ support vector machine (SVM) or other Artificial Neural Networks (ANN) methods for corporate default prediction using the sample-matching method, which produces sample selection biases. In order to avoid the sample selection biases, this paper used all available firm-years samples during the sample period. Yet this brings a new challenge: the number of non-defaulted samples greatly exceeds the defaulted samples, which is referred to as between-class imbalance. Although the SVM algorithm is a powerful learning process, it cannot always be applied to data with extreme distribution characteristics. This paper proposes an enforced support vector machine-based model (ESVM model) for the default prediction in the construction industry, using all available firm-years data in our sample period to solve the between-class imbalance. The traditional logistic regression model is provided as a benchmark to evaluate the forecasting ability of the ESVM model. All financial variables related to the prediction of contractor default risk as well as 7 variables selected by the Multivariate Discriminant Analysis (MDA) stepwise method are put in the models for comparison. The empirical results of this paper show that the ESVM model always outperforms the logistic regression model, and is more convenient to use because it is relatively independent of the selection of variables. Thus, we recommend the proposed ESVM model as an alternative to the traditionally used logistic model.
Article
In the construction bonding business, a complex and comprehensive prequalification or assessment process is done to evaluate contractor, project, and contractual risks. Previous studies have focused mainly on contractor prequalification from the owner's or consultant's perspective. There remains a need for a model to evaluate the contractor and project-specific aspects (i.e., project team and contractual risks) from the surety bonding perspective. This paper identifies and classifies the most relevant evaluation criteria that surety underwriters and brokers consider when evaluating a specific construction project for bonding purposes. Several data collection techniques (questionnaires, one-on-one interviews, and interacting group meetings), with highly experienced surety experts, were conducted to compile a comprehensive and detailed list of the evaluation criteria. Both fuzzy logic and expert systems are combined to develop a decision support system (DSS) for use in contractor and project evaluation. An approach for fuzzy membership function estimation is presented using a traditional membership function estimation technique, integrated with data of contractor prequalification cases. Thirty-eight alternative system configurations are investigated to determine the most accurate one. The system is validated using 32 prequalification cases, and the accuracy of the system is found to be 84.0%.
Article
In construction, many owners mitigate the risk of unforeseen contractor default by accepting only bonded contractors who must endure a rigorous evaluation process by surety brokers and surety underwriters. This evaluation process includes a financial analysis and a review of work on hand and past performance, all of which have reliable structured methods for their evaluation. Additionally, a number of subjective criteria are considered that are more difficult to capture and assess objectively but which can be modeled effectively using fuzzy logic. The purpose of this paper is to illustrate how fuzzy logic and expert systems can be combined to provide a structured approach to evaluating contractors for surety underwriting purposes. Fuzzy logic is used to model both the objective and subjective factors considered in contractor evaluation using linguistic terms, and expert rules are used to capture the surety experts' reasoning process. A fuzzy expert system, SuretyAssist, is presented that can be used to provide an initial evaluation of general contractors as well as periodic reviews to determine whether or not to accept them as clients for bonding. SuretyAssist was validated using 31 actual cases of contractor evaluation and found to be accurate in 81% of the cases.
The Minerals Management Service (MMS) requires offshore oil and gas operators to procure surety bonds to ensure that they meet their decommissioning obligations. According to recent estimates developed by the authors, the total undiscounted cost of decommissioning structures and wells in the Gulf of Mexico in less than 500 ft. water depth is estimated to range between $18-63 billion. The MMS is currently reviewing and updating their supplemental bonding requirements, and in this paper, we discuss the potential impacts of an increase in the bond levels required. While the size of the increase will depend on the amount of risk MMS will assume, the average cost of plugging and abandonment and structure removal operations are between two and eight times greater than the current bond formula. We analyse the surety market, the companies involved in writing bonds and the approximate market share of organisations. This information is neither widely known nor well understood outside a few individuals specialising in the area. We conclude that the largest impacts of increased supplemental bonding requirements would be for exploration and production companies with approximately $10 to $20 million in current liabilities. [Received: April 08, 2009; Accepted: May 26, 2009]
Conference Paper
In the construction industry, owners are constantly seeking practices to reduce the risk of contractor default. One method is the requirement of contractors to obtain surety bonds to bid on and complete construction projects. Similar to contractor prequalification, there are countless factors, both quantitative and qualitative, that the surety underwriter must consider and analyze. Many of these factors are uncertain and difficult to quantify, as every contractor and every construction project is different. The purpose of this paper is to describe the development of a model to assist surety underwriters in the decision-making process of providing contractors with bonding. It incorporates two types of artificial intelligence, fuzzy logic and eural networks, to create a neuro-fuzzy expert system. By combining fuzzy logic with neural networks, the individual limitations of each can be overcome. The resulting neuro-fuzzy expert system is able to model the complex relationship between input and output variables while remaining transparent in its logic. This model is not designed to replace the experience and expert judgment of surety underwriters and brokers, but rather to verify their decisions and validate their thought processes.
Conference Paper
Basic on intrinsic problems in economic activities of construction and special organization form of productivity in construction industry, this paper studies system of construction labor service and employment and holds that construction labor service should offer organized employment in the form of contract labor and develop toward specialization and technician professionalization; at the same time, large or large-medium sized general contractor separates management layer from labor layer and doesn't directly employ construction labor. Construction labor is intensive in those professional and labor cooperative companies (medium-small sized) and workers are employed in the form of “contract worker”. Specialization and professionalization is the road for them to walk. On the other hand, the Chinese-featured Vocational Education and Training System should be realized by the following works, first, to set a certain number of construction technical schools in the small and medium-sized cities and towns in the whole country, which are specialized in cultivating construction-skilled workers. Second, to establish some certain training centers in construction (i.e. skills training centers) in the small and medium-sized cities (towns) by the local governments (or authorized trade associations), offering pre-vocational training on construction services. For the China construction industry, the reform of the above technical schools including the secondary schools of construction and the foundation of regional training centers eliminate the defects of the existing vocational education and training system, and thus effectively improve the construction productivity.
Article
As the prediction of construction firm failure is of great importance for owners, contractors, investors, banks, insurance firms, and creditors, previous studies have developed several models for predicting the probability of construction firm default based on financial ratio analysis. However, to be applied, these models require a considerable quantity of data, including normally distributed data, and the models cannot tolerate too many changing factors. Furthermore, most of the approaches produce sample selection biases. To avoid these disadvantages, this study is the first to integrate the grey system theory with all available firm-year samples during the sample period to provide a new method for predicting the probability of construction firm default. This method not only offers an improved rate of prediction accuracy, but it also offers simpler and clearer procedures as a reference for examining firm default probability and ranks all financial ratios in terms of their level of importance. The research collects and analyzes the financial reports of 92 construction firms in the United States. The proposed model includes only eight ranked variables (financial ratios), and it achieves an 84.8% level of accuracy for predicting construction firm default probability. As a result, practitioners may directly use the model as a means of quickly and conveniently examining their firm default probability with the simple procedures.
Article
Purpose The purpose of this paper is to examine construction bonds, which is a risk management tool for ensuring that projects are delivered successfully, with emphasis on the influence of stakeholders, project characteristics and bonding decision factors. Design/methodology/approach Using case study of completed public building projects, questionnaires were administered on stakeholders that participated in the projects to solicit information on identified issues. Structural equation modelling (SEM) was used to examine relationship among identified factors, and various model selection and validation tests were carried out to arrive at the best-fit model. Findings The final model revealed that type of bond, stakeholders’ influence, project characteristics, risks of bonded projects and bonding decision factors have significant effect on success of bonded construction projects. Of the stakeholders, guarantors and contractors have greater influence on effective administration of bonds. Research limitations/implications The study was limited to Lagos and Ondo states, Nigeria. Data were gathered from clients of public projects, banks and insurance companies (guarantors), as well as contracting, quantity surveying and architectural firms registered with the state governments. This is because of the fact that only such firms can be engaged on projects emanating from the governments. Practical implications To enhance project success, there is a need to adopt construction bond for both public and private projects as against the current practice where it is only mandated for public projects. Originality/value Using SEM, this research examined administration of construction bonds with a view to ascertaining their effects on projects success, thereby providing relevant empirical information for stakeholders for effective administration of construction bond.
Conference Paper
In the construction industry, contractor failure is always possible. Surety bonding is a technique that is used to reduce the risk the owner may face in case a contractor fails to complete a project. When a surety company undertakes to provide a contractor with the bonding facility for a specific construction project, the risks of project completion are shifted from the owner to the surety company. A very complex qualification or assessment process is done to assess project specifics and contractual risks. There are many qualitative and quantitative factors that are taken into consideration, and some of these factors have a nature of uncertainty and subjectivity. The purpose of this paper is to present a methodology for developing a framework for formalizing the contractor and project assessment process to obtain surety bonds for specific construction projects. The framework includes the integration of multiple technologies (genetic algorithms, fuzzy logic, neural networks, and learning from examples) into a single application.
Article
At the present stage,China's project guarantee system is not perfect, there are problems such as the same guarantor guarantee the owner and the contractor, the risk consciousness of the construction project market is not strong, the guarantee issued by guarantee agencies is not standard, and the guarantee rate of the engineering is not unified. Such serious problems have influenced the development of China's construction market, reducing the competitiveness of China's construction enterprises in the international market. Actual survey raised a number of recommended countermeasures, such as actively carry out publicity and training work, strengthen legislation and perfect contract management, combination of compulsory and voluntary implementation, actively cultivate the professional guarantee gompanies and engineering guarantee market, perfect social credit system and social security systemm, and determine the reasonable project guarantee fees to establish a correct sense of risk, aiming to further improve our project guarantee system.
Article
This is the first study to apply the barrier option model to predict defaults of construction contractors and to assert that the path-dependent characteristic of the model is very suitable for describing the behavior of contractor default. Different from existing contractor-default prediction models, this research uses a much larger contractor sample in empirical analyses to alleviate sample-selection biases, and employs a Receiver Operating Characteristics (ROC) curve to assess the model performance. Empirical results of this study show that the proposed model outperforms traditional financial ratio models in differentiating the risk of defaulted and nondefaulted construction contractors. Additionally, the barrier option model has markedly better discriminatory power than when applied to non-construction-related industries. The results of this paper support the postulation that the barrier option model has significant advantages for the construction industry.
Article
This paper aims to predict construction contractor default, which is excluded by most extant studies, due to the distinct characteristics of construction industry. Default predicting models developed in past literatures are mostly built by accounting information, yet accounting sheets have innate flaws. To calculate default probability, several recent studies applied the option pricing theory, which presumes that the stock market is efficient. This presumption isn't always true in real life. In this paper, a hybrid model is proposed. It combines information from both models by inputting the default probability from the option-based model into the accounting-based model. As the measure of models' predicting performance, the Area Under the receiver operating characteristic Curve (AUC) is used. Empirical results show that the hybrid model (AUC: 0.8732) outperforms both the accounting-based model (AUC: 0.7519) and the option-based model (AUC: 0.8581). This result shows that accounting or stock market information alone is not sufficient to explain real-world behavior. It is suggested that the hybrid model be used as an alternative prediction model of construction contractor default.
Article
With growing concern about global warming and climate change, the construction industry, as a major contributor to greenhouse gas (GHG) emissions, has begun to realize its essential role in improving the environment by reducing emissions through the life cycle of buildings and infrastructure. While a considerable amount of prior research has been devoted to assess the environmental impacts of sustainable design alternatives and post-construction operations, there is an increased awareness of, and demand for, managing greenhouse gas (GHG) emissions during the building process. One approach suggested by previous researchers is to adopt an innovative competitive bidding system which includes the estimated environmental cost incurred during the construction phase as one of the evaluation criteria in addition to cost and schedule. The main problem with this practice, however, is that there are no enforcement mechanisms to guarantee the performance of GHG emissions. As a result, it may induce contractor's opportunistic bidding behaviour which could lead to many issues such as abnormal low bids and poor environmental performance. To address the problem, this research proposed a framework which adds another dimension to the traditional project management structure and investigates the possibility of applying a green performance bond to insure against the risk of discrepancy between the actual and expected performance of GHG emissions during construction. Drawing an analogy from the construction performance bond, a conceptual model is presented to illustrate how to utilize this innovative surety product to manage embodied carbon in the building process. The result shows that from the owner's perspective it is a way to encourage contractors to improve their environmental performance through financial means.
Article
Launched in 2012, the Principles for Sustainable Insurance serve as a global framework for the insurance industry to address environmental, social, and governance risks and opportunities. This report presents the findings of an exploratory study looking at the influence of environmental, social, and governance (ESG) risks on surety underwriting. Our findings come from a global survey of the insurance industry that sought to understand whether and how insurance and reinsurance companies are integrating ESG risks into the surety underwriting of infrastructure projects.
Article
The construction industry is a high debt ratio, high operating risk and high financial leverage business. The financial instability causes a chain reaction among funds transferred among companies, therefore restricting competitiveness within the industry. The industry’s character and accounting principles of firm-years are different from that of other industries. Creating a hypothetical model of a financial crisis within the construction industry is therefore necessary. Application of this model to real scenarios involving relevant parties can help to forecast a financial crisis in the future. This study applied the market-based model, accounting-based model, hybrid models to predict a financial crisis. These models were then compared to find which can best predict a company that will default. Also, in this paper choosing variables for the Hybrid and Accounting-based models can promote their performance. Finally, the best can be selected for predicting stability.
Conference Paper
Full-text available
In the United States, construction contracts require that contractors submit surety bonds, hence shifting the contractor's risks to the sureties. In order to take on the risks of project completion, the sureties employ a complex time-consuming evaluation process that assesses several factors of a contractor that are subjective to make a surety credit recommendation. Several small and emerging contractors find it very difficult to attain bonding capacities as they do not know the factors that go into the sureties' consideration to extend surety credit. The purpose of this study is to identify the surety bonding criterion that influences bonding decisions through a series of interviews with surety professionals possessing extensive experience in the bonding evaluation process. The outcome is a list of factors that underwriters consider in issuing a surety credit to contractors. Understanding the surety bonding criteria employed by underwriters enhances contractors' ability to secure required bonding capacities for their future projects.
Article
Conditional performance guarantees with risky collaterals are specific bonding instruments that are not credit extensions or require only a service fee. Instead, they resemble a credit default swap (CDS) that is essentially an insurance contract and can thus be priced accordingly. A CDS-based model is proposed here for pricing these instruments. The model incorporates both contractor default probability and the recovery risk of collateral. It also allows for explicit specification of bonding parameters such as the promised amount of payment in the event of default. For model implementation, a quasi-KMV-Merton approach is proposed for the estimation of contractor default probability. The historical market prices and basic accounting data of publicly traded construction firms in the Taiwan Economic Journal Database (TEJD) are used to test the model. The model demonstrates effective statistical power to distinguish categorized samples of the firms. It shows that the current industrial practice of asking a standard service rate of 1% tends to charge too little for financially distressed firms and too much for normal ones.
Performance bonding in the construction industry
  • T N Dufek
Linguistic analysis of risk in project planning
  • R Kangari
  • M Bekheet
Construction bonding update
  • R Agosta
The surety-bonding mess
  • O Collins
Chapter 7 ” Construction contracting 3rd Ed
  • R H Clough
Risk assessment of construction bonds underwriting using neural network technique
  • R Kangari
  • M Bekheet
Constructing questions for interviews and questionnaires: Theory and practice
  • W Foody
The state of bonding for the construction industry
  • R Geyer
Fuzzy logic flowers in Japan
  • D G Schwartz
  • G J Killer
The management research handbook Routledge Chapman and
  • N C Smith
  • P Dainty
Guidelines for evaluating contract bond forms and contract documents Duane Morris & Heckscher Philadelphia
  • A J Ruck
  • J S Bevan