Reducing Agency Costs in a Supply Chain by Contracting on Retail Inventory

Abstract

This paper provides a theory to explain how recent phenomena in the retailing industry, such as electronic data interchange, continuous replenishment, and consignment sales, are related to mitigating agency costs in a distribution channel. These phenomena are linked to the manufacturer?s ability to monitor retail inventory levels. When the manufacturer is unable to monitor retail inventory levels and resale-price maintenance is illegal, the manufacturer uses the wholesale price to regulate both retail prices and inventory levels. However, when the manufacturer can monitor retail inventory, he will choose to subsidize unsold inventory in various forms. This ability to subsidize unsold inventory, we demonstrate, helps the manufacturer mitigate the trade-off between retail prices and inventory levels. The Accounting/Information systems, such as Electronic Data Interchange (EDI), help the manufacturer monitor retail inventory, and thus play a crucial role in reducing contract incompleteness in supply chains.

JEL Classification: M31, M11, M30, D43, L13