Optimal Contract Under Asymmetric Information about Inequity Aversion
29 Pages Posted: 29 Jun 2015 Last revised: 2 Aug 2023
Date Written: October 30, 2019
Abstract
One of the key results coming from the experimental literature on efficiency of supply chain contracts is that the single most detrimental cause of inefficiency is negotiations breakdown due to incomplete information about preferences for fairness. To date, the optimal screening contract has not been characterized, leaving open a question of both the structure of the contract and the upper bound on supply chain efficiency (second-best). Using a mechanism design approach, we prove that the optimal screening menu consists of a single contract positioned on the Pareto frontier, and characterize its location. This result establishes a direct link between a large volume of literature on the Ultimatum Game and the research stream on supply chain contracts, justifying why findings in one are directly relevant for the other. Therefore, considering the amount of experimental evidence in both streams of literature speaking of a large percentage of negotiation breakdown, the managerial insight of this study is to avoid the ultimatum bargaining protocol, when possible.
Keywords: behavioral operations, supply chain coordination, fairness, contract theory, mechanism design
JEL Classification: c70, d63, d82, l14
Suggested Citation: Suggested Citation