Social preferences and screening contracts
Screening contracts (or “menu of contracts”) are frequently used for aligning the incentives in supply chains with private information. In this context, it is assumed that all supply chain parties are strictly (expected) profit maximizing. However, previous behavioral work on contracting under asymmetric information in supply chains shows that this is a critical assumption. In fact, it seems that subjects have other-regarding preferences and are willing to invest money for achieving higher relative payoffs. Interestingly, the classical approach to design incentive compatible mechanisms gives the agent cheap leeway to increase relative pecuniary payoffs, because the agent is left (almost) indifferent between two contract alternatives. In other words, we argue (and actually observe in laboratory experiments) that this classical approach of contract design allows the agent showing other-regarding preferences at low cost. Since the agent’s better relative performance solely stems from reducing the suppliers payoffs, we observe a substantial negative impact on the overall supply chain performance. The present work relaxes the assumption of the profit maximizing buyer (agent) in a serial supply chain for a lot sizing framework with asymmetrically distributed holding cost information and deterministic end-customer demand. The study provides researchers and managers an approach on how to account for other-regarding preferences by designing a contract that anticipates such behavior while providing a solution method for the resulting non-linear mathematical program. A numerical study compares the advantages of the “behavioral robust” contract against the classical screening contract. The results highlight that supply chain performance losses can be substantially reduced under the behavioral robust contract.
screening contracts, supply chain
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