Performance-based ship management contracts using the Shipping KPI standard

Abstract

An important benefit of performance-based contracts is a better risk and profit-sharing mechanism and by that a means to overcome the “split incentive” problem in current shipping contracts. “Split incentive” means that the risk or cost of implementing beneficial measures does not fall on the same party that gets the benefits. However, performance-based contracts do not come without challenges. These are related to defining commonly agreed performance measurements and an incentive scheme that can counteract problems like allocative efficiency and information asymmetry. This paper gives an example of how these challenges can be addressed by using the Shipping KPI standard. The purpose of the paper is to show how a standard set of key performance indicator definitions and corresponding benchmark values can greatly simplify the design of a performance-based contracts scheme by providing well-defined references for both owner and manager. This is done by creating a bonus and penalty scheme where the payment is related to a single variable (budget performance), while a number of quality indicators control whether a bonus will be paid at all. The paper will discuss this principle in relationship to problems identified in literature on performance-based contracting and ship management and provide an overview of possible strengths and weaknesses.