Full Quantity or Full Credit? Choosing the Right Buyback Policy for A Loss-Averse Retailer

43 Pages Posted: 25 May 2021 Last revised: 2 Jul 2021

See all articles by Yinghao Zhang

Yinghao Zhang

University of Cincinnati

Peiwen Yu

Chongqing University - School of Economics and Business Admininstration

Tianjun Feng

Fudan University - School of Management

Date Written: May 25, 2021

Abstract

This paper compares two forms of buyback policies commonly adopted in practice -- a traditional full-quantity partial-credit (FQ) buyback contract and an alternative full-credit partial-quantity (FC) contract. Standard theory based on profit maximization suggests that both policies can achieve channel-coordinating solutions when applied in a dyadic supplier-retailer setting. Consequently, neither policy should dominate the other by simultaneously offering higher expected profits for both parties. However, prior behavioral research in buyback contracts suggests that retailer's ordering decisions are often subject to behavioral biases. First, through a controlled lab experiment, we discover that the ordering decisions made by human retailers are significantly higher under the FC contract than under the FQ contract, although standard theory predicts no difference. This phenomenon is consistent with the behavioral tendency of loss aversion. Next, we study how the performances of the two contracts compare as a result of the retailer's loss-averse behavior. On the one hand, from a contract designer's perspective, it becomes feasible to design a channel-coordinating FC buyback contract that makes both players better off compared with a coordinating FQ contract. On the other hand, when the supplier has the authority to set contract terms, she should choose the FC policy to maximize her expected profit. However, in a situation where the wholesale price is exogenously given, the supplier should instead choose a traditional FQ contract for a loss-averse retailer. Our results can help inform both the contract designers and the supply managers on what types of buyback policies to use in different settings.

Keywords: Buyback contract, return policy, loss aversion, behavioral operations

Suggested Citation

Zhang, Yinghao and Yu, Peiwen and Feng, Tianjun, Full Quantity or Full Credit? Choosing the Right Buyback Policy for A Loss-Averse Retailer (May 25, 2021). Available at SSRN: https://ssrn.com/abstract=3852442 or http://dx.doi.org/10.2139/ssrn.3852442

Yinghao Zhang (Contact Author)

University of Cincinnati ( email )

2529 Campus Green Dr.
Cincinnati, OH 45221
United States

Peiwen Yu

Chongqing University - School of Economics and Business Admininstration ( email )

Shazheng Str 174, Shapingba District
Chongqing, Chongqing 400030
China

HOME PAGE: http://sites.google.com/view/peiwen-yu/

Tianjun Feng

Fudan University - School of Management ( email )

No. 670, Guoshun Road
No.670 Guoshun Road
Shanghai, 200433
China

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