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Introduction
During a procurement process, a low winning tender can be bad news for the procurement agency if the project leads to financial distress of the winning contractor who could go bankrupt before finishing the project. Of the 850,000 contractors in business in the United States in 2004, only 650,000 were still in business in 2006; a failure rate of 23.6 per cent. 1 Contractor bankruptcy can be very costly for the agency: the direct costs of bankruptcy (e.g., lawyers) make up 7-20 per cent of the liquidation proceeds and the indirect costs (e.g., delays) are estimated to be even higher (White, 1989). To be more specific, the 80,000 contractors that went bankrupt in the U.S. construction industry between 1990 and 1997 left unfinished construction projects with liabilities exceeding U.S.$ 21 billion. 2
To deal with the problem of bankrupt contractors, several governments introduced surety bonds in public procurement (among others Brazil, Canada, Italy, Japan, and the U.S.A.). In the U.S.A. the federal Miller Act requires a surety bond from all construction contractors if the value of the project exceeds U.S.$ 100.000. 3 Surety bonds are used as well in the private sector . For instance, 17 per cent of the surety bonds in the U.S.A. (Russell, 1999, p. 4) were accounted for by private agencies. The U.S. practice uses two kinds of bonds, a performance bond and a payment bond. We focus our analysis on the performance bond whose size is usually 100 per cent of the project value and protects the agency from financial loss if the contractor fails to fulfil the contract. 4 Surety bonds are issued by surety and insurance companies that are approved by the U.S. Treasury. In contrast to most insurance contracts or letters of credit, surety bonds are not designed to cover the expected loss in case of failure but to avoid failure. This is done by screening the project's risks (inherent risk, type of coverage, etc.) as well as the contractor's risks (tangible assets, past performance, etc.) 5 and charging a risk-adjusted insurance premium. Premia in the U.S. vary between 0.5 per cent and 3 per cent of the project value (source : www.sio.org) and are derived from rate manuals issued by the Surety &...
