Performance Bond: Cost, Benefit, and Paradox for the Public Highway Agencies
In the highway industry, one of the main methods to prequalify a contractor is to determine if a performance bond can be secured from a commercial surety. The current performance bonding system does not differentiate between high-performing and marginal contractors. Two companies with the same level of financial assets have the same capability to furnish performance bonds. This paper details an analysis of the benefits and costs of performance bonds and reports the results of a study that used case studies in five state departments of transportation (DOTs): Iowa, Oklahoma, Utah, Virginia, and Washington. Structured interviews were also conducted with members of the construction contracting sector and the surety industry. The results showed that although average default rates were less than 1.0% and a performance bond added an average of 1.5% to the cost of every construction project, DOTs and contractors were reluctant to eliminate performance bonds from the industry. There lies a paradox: construction project owners are willing to pay an additional 1.5% to protect themselves from an event that occurs less that 1.0% of the time.
This is a manuscript of an article from Transportation Research Record 2408 (2014): doi:10.3141/2408-01. Posted with permission.