Use of Warranties on Highway Projects: A Real Option Perspective

Abstract

Since the introduction of warranty provisions in federal highway jobs, more and more state departments of transportation (DOTs) have considered the use of such provisions to protect their initial investment. This paper describes the pros and cons of warranty contracting in highway construction based on a survey of warranty practices in the United States. In particular, the need for state DOTs to buy a warranty for a well-built project is questioned. As an alternative, this paper introduces the warranty option, which gives the DOT the right to buy a warranty only if it becomes necessary at the end of construction. This option is exercised if the performance on site warrants it. This paper describes the mechanics of the warranty option and its advantages over the conventional warranty. A bid evaluation model is also developed for the