Managing Reputation Risk in Supply Chains: The Role of Risk-sharing under Limited Liability

Management Science, Forthcoming

44 Pages Posted: 1 Aug 2020

See all articles by Vibhuti Dhingra

Vibhuti Dhingra

University of British Columbia (UBC) - Division of Operations and Logistics

Harish Krishnan

University of British Columbia (UBC) - Sauder School of Business

Date Written: June 25, 2020

Abstract

When a supplier fails to comply with social and environmental standards, the buyer’s reputation suffers. Reputation costs can typically be very high for the buyer whereas the supplier’s liability is often limited. Conventional procurement strategies like dual sourcing mitigate the buyer’s operational risk, but often do so at the expense of increasing its reputation risk and sourcing costs. In this paper, we propose a risk-sharing contract for managing the buyer’s reputation concerns. We find that by sharing some of the supplier’s operational loss, the buyer may (in some conditions) decrease its reputational risk but this has to be balanced against an increase in the operational risk. Risk-sharing also reduces sourcing costs because the buyer takes on some of the worst-case loss of a wealth-constrained supplier. These results suggest that risk-sharing can be superior, as a procurement strategy, to conventional approaches like dual sourcing or penalty contracts. This is true when reputation and sourcing costs are a significant concern, and operational costs are not that high. Under some conditions, the buyer may choose risk-sharing even if it increases reputation risk in order to reduce procurement costs.

Keywords: contracts and incentives; risk management; social responsibility in supply chains

Suggested Citation

Dhingra, Vibhuti and Krishnan, Harish, Managing Reputation Risk in Supply Chains: The Role of Risk-sharing under Limited Liability (June 25, 2020). Management Science, Forthcoming, Available at SSRN: https://ssrn.com/abstract=3644017

Vibhuti Dhingra (Contact Author)

University of British Columbia (UBC) - Division of Operations and Logistics ( email )

2053 Main Mall
Vancouver, BC V6T1Z2
Canada

Harish Krishnan

University of British Columbia (UBC) - Sauder School of Business ( email )

2053 Main Mall
Vancouver, BC V6T 1Z2
Canada

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