Contracting with Private Knowledge of Production Capacity

34 Pages Posted: 27 Oct 2015

See all articles by Leon Yang Chu

Leon Yang Chu

University of Southern California - Data Sciences and Operations; Cheung Kong Graduate School of Business

David E. M. Sappington

University of Florida - Department of Economics; National Bureau of Economic Research (NBER)

Date Written: Winter 2015

Abstract

We analyze the design of procurement contracts when the supplier is privately informed about both his innate production capacity (K) and his innate unit cost of production. We identify conditions under which the supplier will strategically employ an inefficient production technology to expand output above K. We also show that when the buyer employs the simple fixed‐price cost‐reimbursement (FPCR) contracts in the setting examined by Rogerson (2003), the supplier has no incentive to exaggerate K. Furthermore, the buyer can secure with FPCR contracts at least 75% of the surplus she secures with fully optimal contracts.

Suggested Citation

Chu, Leon Yang and Sappington, David E. M., Contracting with Private Knowledge of Production Capacity (Winter 2015). Journal of Economics & Management Strategy, Vol. 24, Issue 4, pp. 752-785, 2015. Available at SSRN: https://ssrn.com/abstract=2680402 or http://dx.doi.org/10.1111/jems.12112

Leon Yang Chu (Contact Author)

University of Southern California - Data Sciences and Operations ( email )

701 Exposition Blvd
Los Angeles, CA
United States

Cheung Kong Graduate School of Business ( email )

Oriental Plaza, Tower E3
One East Chang An Avenue
Beijing, 100738
China

David E. M. Sappington

University of Florida - Department of Economics ( email )

224 Matherly Hall
Gainesville, FL 32611-7140
United States
352-392-3904 (Phone)
352-336-1420 (Fax)

National Bureau of Economic Research (NBER)

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Cambridge, MA 02138
United States

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