Behavioral Contract Design Under Asymmetric Forecast Information

Abstract

ABSTRACTWe investigate the capacity investment decision of a supplier who produces a critical component for a buyer. An incentive conflict is present, because the buyer possesses private forecast information about end customer demand. We use laboratory experiments to test the performance of nonlinear capacity reservation contracts offered by the supplier. We show that both bounded rationality and fairness preferences consistently lead to buyer contract choices that harm supplier performance and overall supply chain performance. We therefore examine several capacity reservation contracts that take into account the buyer's inability to maximize utility (bounded rationality) and/or the buyer's motives (inequity aversion). We find that considering these behavioral aspects in contract design enhances supply chain performance.