Contract Design by Service Providers with Private Effort

Forthcoming, Management Science

69 Pages Posted: 29 Jan 2014 Last revised: 22 Jan 2017

Hao Zhang

UBC Sauder School of Business

Sampath Rajagopalan

University of Southern California - Marshall School of Business

Guangwen Kong

University of Minnesota - Industrial & System Engineering

Date Written: January 17, 2017

Abstract

We investigate the performance of two commonly used pricing schemes -- hourly-rate contract and two-part tariff -- in service environments where the buyer's valuation is invisible to the service provider and the provider's effort may not be visible to the buyer. In the private effort environment, we further distinguish between situations where the contract may be based on the outcome or on the effort reported by the provider. We show that under the two-part tariff, when effort is private, the provider can achieve the same profit as under public effort by contracting on reported effort and will be worse off by contracting on outcome. Under the hourly-rate contract, compared with the public effort case, the provider may be better or worse off in keeping effort private and contracting on the reported effort, and the trade-off is affected by the degree of outcome uncertainty in a nontrivial way. We find that a provider's profits under an hourly-rate contract are as good as under a two-part tariff over a sizable parameter regime when contracting on reported effort.

Keywords: Pricing, Service Contracts, Private Information

JEL Classification: D82, L14, L15

Suggested Citation

Zhang, Hao and Rajagopalan, Sampath and Kong, Guangwen, Contract Design by Service Providers with Private Effort (January 17, 2017). Forthcoming, Management Science. Available at SSRN: https://ssrn.com/abstract=2386361 or http://dx.doi.org/10.2139/ssrn.2386361

Hao Zhang

UBC Sauder School of Business ( email )

2053 Main Mall
Vancouver, BC V6T 1Z2
Canada

Sampath Rajagopalan (Contact Author)

University of Southern California - Marshall School of Business ( email )

701 Exposition Blvd
Los Angeles, CA 90089
United States

Guangwen Kong

University of Minnesota - Industrial & System Engineering ( email )

111 Church Street S.E.
Minneapolis, MN 55455
United States

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