Contracting and Coordination Under Asymmetric Production Cost Information

Production and Operations Management, 21(2)345-260

36 Pages Posted: 17 Jan 2008 Last revised: 12 Nov 2012

See all articles by M. Çakanyıldırım

M. Çakanyıldırım

University of Texas at Dallas - Naveen Jindal School of Management

Qi Feng

Purdue University - Krannert School of Management

Xianghua Gan

Southwestern University of Finance and Economics (SWUFE) - School of Business Administration

Suresh Sethi

University of Texas at Dallas - Naveen Jindal School of Management

Date Written: March 9, 2010

Abstract

We analyze a supply chain consisting of a supplier and a retailer. The supplier’s unit production cost, which characterizes his type, is only privately known to him. When trading with the retailer, the supplier demands a reservation profit that depends on his unit production cost. We model this problem as a game of adverse selection. In this model, the retailer offers a menu of contracts, each of which consists of two parameters: the ordering quantity and the supplier’s share of the channel profit. We show that the optimal contract depends critically on a surrogate measure. This measure represents the size of the outside market that the supplier may serve if not trading with the retailer. An important implication from our analysis is that information asymmetry alone does not necessarily induce loss in channel efficiency. The optimal contract can coordinate the supply chain as long as the size of the outside market is comparable to the quantities required by the retailer. We further discuss the retailer’s preference of the supplier’s type under different market conditions, as well as evaluate the effects of the supplier’s reservation profit, the retail price, and the demand uncertainty on the optimal contract.

Keywords: Asymmetric Information, Type-dependent reservation profits, Type-independent reservation profits, Coordination, Supply Contract, Adverse Selection, Contract theory

JEL Classification: M11, C61, C7, D82

Suggested Citation

Cakanyildirim, Metin and Feng, Qi and Gan, Xianghua and Sethi, Suresh, Contracting and Coordination Under Asymmetric Production Cost Information (March 9, 2010). Production and Operations Management, 21(2)345-260. Available at SSRN: https://ssrn.com/abstract=1084584

Metin Cakanyildirim (Contact Author)

University of Texas at Dallas - Naveen Jindal School of Management ( email )

P.O. Box 830688
Richardson, TX 75083-0688
United States

Qi Feng

Purdue University - Krannert School of Management ( email )

1310 Krannert Building
West Lafayette, IN 47907-1310
United States

Xianghua Gan

Southwestern University of Finance and Economics (SWUFE) - School of Business Administration ( email )

No.55 Guanghuacun Street
Chengdu, 610074
China

Suresh Sethi

University of Texas at Dallas - Naveen Jindal School of Management ( email )

800 W. Campbell Road, SM30
Richardson, TX 75080-3021
United States

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