Contractor Financial Prequalification - Cash Flow Based Structural Model Associated with Dynamic Threshold
Date Issued
2012
Date
2012
Author(s)
Lee, Shu-Yi
Abstract
It is very important for project owner to screen out incapable contractors in the process of investigating and qualifying contractors to ensure that the contractors’ capabilities conform to the requirements of the project. Contractor prequalification involves a screening procedure based upon a predetermined set of criteria necessary for completing the project successfully. The criteria generally include: financial standing, technical ability, management capability, health and safety, and reputation.
This study employs an innovative approach by using the cash flow based structural model with dynamic threshold by Liao, Chen and Su (2007) to assess the contractor’s financial standing in the prequalification stage. The financial condition of a construction company is highly related to whether it can generate sufficient cash flow to service its debt, i.e. the degree of credit risk. If a construction company is unable to fulfill its debt, it will be delinquency or even bankrupt. This will cause a delay or failure on performing its construction project. Therefore, the evaluation of contractor financial standing is a crucial issue in contractor prequalification. The cash flow based structural model with dynamic threshold can simulate and produce the credit quality score of each construction contractor from the historical cash flow of a firm. Through this credit quality score, owner can learn the financial condition of each construction contractor and thus can differentiate financial qualified and financial disqualified contractor.
This study employs the Area Under Curve (AUC) to evaluate the discriminatory performance of the model in ranking the credit quality of construction contractor in three years and uses S&P issuer credit ratings as the benchmarks. The empirical results show that the cash flow based structural model with dynamic threshold performs an excellent discriminatory power: AUC = 0.8611 in the first year; AUC = 0.8333 in the second year and AUC = 0.8194 in the third year. These results indicate that this model is useful in assessing the credit risk of construction contractor. Since this model only requires the information of accounting statements, it is applicable in both listed and private construction contractors.
Subjects
construction industry
contractor prequalification
credit risk
cash flow based structural model with dynamic threshold
ROC curve
Type
thesis
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