Sourcing Contract Under Countervailing Incentives

28 Pages Posted: 22 Mar 2019

See all articles by Qi Feng

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: February 28, 2019

Abstract

We study a retailer's sourcing contract when the supplier's reservation profit (offered by his outside options) depends on his cost, which is privately known to only the supplier. An interesting discovery from our analysis is that supply chain coordination may be achieved despite the information asymmetry between the two firms regarding the supplier's type (i.e., his cost). This happens when the marginal contribution of the supplier's cost efficiency to the trade matches with the supplier's marginal reservation profit. In this case, the optimal contract quantities maximize the supply chain profits for the respective supplier types, and no information rent is paid to any supplier type. For the general case, we show that, regardless of his type, the supplier may have an incentive to overstate or understate his cost, depending on whether or not his marginal contribution to the trade exceeds his marginal reservation profit. We demonstrate six possible forms of the optimal contract. Observations from our analysis contrast with those derived from previous studies, complementing the theory of countervailing incentives.

Keywords: supply contract, adverse selection, supply chain efficiency, type-dependent reservation profit, countervailing incentives

Suggested Citation

Feng, Qi and Gan, Xianghua and Sethi, Suresh, Sourcing Contract Under Countervailing Incentives (February 28, 2019). Available at SSRN: https://ssrn.com/abstract=3344247 or http://dx.doi.org/10.2139/ssrn.3344247

Qi Feng

Purdue University - Krannert School of Management ( email )

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

Xianghua Gan (Contact Author)

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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