Sourcing with Deferred Payment and Inspection under Supplier Product Adulteration Risk

34 Pages Posted: 23 Sep 2012 Last revised: 21 Aug 2014

See all articles by Huaxia Rui

Huaxia Rui

University of Rochester - Simon Business School

Guoming Lai

University of Texas at Austin - Red McCombs School of Business

Date Written: June 15, 2013

Abstract

We study the deferred payment and inspection mechanisms for mitigating supplier product adulteration, with endogenous procurement decision and general defect discovery process. We first derive the optimal deferred payment contract, which reveals that either entire or partial deferral can arise, depending on the moral hazard severity and the information accumulation rate. Because of the supplier's incentive to adulterate, the optimal procurement quantity under deferred payment generally is smaller than the first-best quantity. We then investigate the inspection mechanism and characterize the equilibrium. We find that under the inspection mechanism, the optimal procurement quantity is no less than the first best. A comparison between these two mechanisms shows that the deferred payment mechanism generally can outperform the inspection mechanism when either the market size is small or the profit margin is low. However, we find that these two mechanisms can also be complementary, for which we characterize a necessary condition.

Keywords: quality control; deferred payment; inspection; moral hazard

Suggested Citation

Rui, Huaxia and Lai, Guoming, Sourcing with Deferred Payment and Inspection under Supplier Product Adulteration Risk (June 15, 2013). Available at SSRN: https://ssrn.com/abstract=2150736 or http://dx.doi.org/10.2139/ssrn.2150736

Huaxia Rui (Contact Author)

University of Rochester - Simon Business School ( email )

Rochester, NY 14627
United States

Guoming Lai

University of Texas at Austin - Red McCombs School of Business ( email )

Austin, TX 78712
United States

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