Optimal Contract Under Asymmetric Information about Inequity Aversion

29 Pages Posted: 29 Jun 2015 Last revised: 2 Aug 2023

See all articles by Valery Pavlov

Valery Pavlov

University of Auckland Business School

Elena Katok

University of Texas at Dallas

Wen Zhang

Baylor University - Hankamer School of Business

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

Pavlov, Valery and Katok, Elena and Zhang, Wen, Optimal Contract Under Asymmetric Information about Inequity Aversion (October 30, 2019). Available at SSRN: https://ssrn.com/abstract=2623821 or http://dx.doi.org/10.2139/ssrn.2623821

Valery Pavlov (Contact Author)

University of Auckland Business School ( email )

12 Grafton Rd
Private Bag 92019
Auckland, 1010
New Zealand

Elena Katok

University of Texas at Dallas ( email )

Jindal School of Management
800 W. Campbell Dr.
Richardson, TX 75080
United States

HOME PAGE: http://www.utdallas.edu/~ekatok/

Wen Zhang

Baylor University - Hankamer School of Business ( email )

One Bear Place #98006
Waco, TX 76798
United States

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