Salesforce Contracting under Uncertain Demand and Supply

35 Pages Posted: 18 Oct 2017 Last revised: 10 Mar 2018

Tinglong Dai

Johns Hopkins University - Carey Business School

Kinshuk Jerath

Columbia University - Columbia Business School

Date Written: March 7, 2018

Abstract

We consider the compensation design problem of a firm that hires a salesperson to exert effort to increase demand. We assume both demand and supply to be uncertain, with sales being the smaller of demand and supply, and assume that if demand exceeds supply then unmet demand is unobservable (demand censoring). Under moral hazard (i.e., when the salesperson’s effort is unobservable to the firm), we show that the optimal contract has an extreme convex form in which a bonus is provided only for achieving the highest sales outcome, even if low realized sales are due to low realized supply (on which the salesperson has no influence). Under double moral hazard (i.e., when the firm can also take supply-related actions that are unobservable to the salesperson), we show that the optimal contract is smoother as it involves positive compensation for intermediate sales outcomes; in fact, under certain conditions, the contract is concave in sales. We also determine conditions under which, if possible, the firm should postpone contracting until after supply is realized.

Keywords: Salesforce compensation, yield uncertainty, double moral hazard, demand censoring.

JEL Classification: D82, D86, J33

Suggested Citation

Dai, Tinglong and Jerath, Kinshuk, Salesforce Contracting under Uncertain Demand and Supply (March 7, 2018). Columbia Business School Research Paper No. 17-103. Available at SSRN: https://ssrn.com/abstract=3054963 or http://dx.doi.org/10.2139/ssrn.3054963

Tinglong Dai (Contact Author)

Johns Hopkins University - Carey Business School ( email )

100 International Drive
Baltimore, MD 21202
United States

HOME PAGE: http://tinglongdai.com

Kinshuk Jerath

Columbia University - Columbia Business School ( email )

3022 Broadway
New York, NY 10027
United States

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