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Shortcuts in Complex Engineering Systems: A Principal‐Agent Approach to Risk Management

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  • Russ Garber
  • Elisabeth Paté‐Cornell

Abstract

In this article, we examine the effects of shortcuts in the development of engineered systems through a principal‐agent model. We find that occurrences of illicit shortcuts are closely related to the incentive structure and to the level of effort that the agent is willing to expend from the beginning of the project to remain on schedule. Using a probabilistic risk analysis to determine the risks of system failure from these shortcuts, we show how a principal can choose optimal settings (payments, penalties, and inspections) that can deter an agent from cutting corners and maximize the principal's value through increased agent effort. We analyze the problem for an agent with limited liability. We consider first the case where he is risk neutral; we then include the case where he is risk averse.

Suggested Citation

  • Russ Garber & Elisabeth Paté‐Cornell, 2012. "Shortcuts in Complex Engineering Systems: A Principal‐Agent Approach to Risk Management," Risk Analysis, John Wiley & Sons, vol. 32(5), pages 836-854, May.
    • Handle: RePEc:wly:riskan:v:32:y:2012:i:5:p:836-854
    DOI: 10.1111/j.1539-6924.2011.01736.x
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    References listed on IDEAS

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    1. Daniel Kahneman & Amos Tversky, 2013. "Prospect Theory: An Analysis of Decision Under Risk," World Scientific Book Chapters, in: Leonard C MacLean & William T Ziemba (ed.), HANDBOOK OF THE FUNDAMENTALS OF FINANCIAL DECISION MAKING Part I, chapter 6, pages 99-127, World Scientific Publishing Co. Pte. Ltd..
    2. Flyvbjerg,Bent & Bruzelius,Nils & Rothengatter,Werner, 2003. "Megaprojects and Risk," Cambridge Books, Cambridge University Press, number 9780521009461, October.
    3. Robin L. Dillon & M. Elisabeth Paté-Cornell & Seth D. Guikema, 2003. "Programmatic Risk Analysis for Critical Engineering Systems Under Tight Resource Constraints," Operations Research, INFORMS, vol. 51(3), pages 354-370, June.
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    Cited by:

    1. Martina de Gramatica & Fabio Massacci & Woohyun Shim & Uğur Turhan & Julian Williams, 2017. "Agency Problems and Airport Security: Quantitative and Qualitative Evidence on the Impact of Security Training," Risk Analysis, John Wiley & Sons, vol. 37(2), pages 372-395, February.
    2. Michael J. Pennock, 2015. "Defense Acquisition: A Tragedy of the Commons," Systems Engineering, John Wiley & Sons, vol. 18(4), pages 349-364, July.
    3. Sean D. Vermillion & Richard J. Malak, 2020. "An investigation on requirement and objective allocation strategies using a principal–agent model," Systems Engineering, John Wiley & Sons, vol. 23(1), pages 100-117, January.
    4. Elisabeth Paté‐Cornell & Louis Anthony Cox, 2014. "Improving Risk Management: From Lame Excuses to Principled Practice," Risk Analysis, John Wiley & Sons, vol. 34(7), pages 1228-1239, July.

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