Manufacturer–retailer contracting with asymmetric information on retailer's degree of loss aversion

Abstract

Abstract In a recent paper [Wang C., Webster S., 2007. Channel coordination for a supply chain with a risk-neutral manufacturer and a loss-averse retailer. Decision Sciences 38 (3), 361–389.], the authors study a supply chain consisting of a risk neutral manufacturer and a loss averse retailer and show that the supply chain can be coordinated by three contracts: buy back (BB), gain/loss sharing (GL) and gain/loss sharing and buy back (GLB). They assume that the retailer's degree of loss aversion is common knowledge. However, this assumption cannot reflect real situations, since in the real industry, one party's degree of loss aversion is usually unknown by other parties. In the present paper, we propose a principal-agent model, assuming the retailer's degree of loss aversion to be asymmetric information. Within the principal-agent framework, we obtain the following results: (1) An optimal MGL (modified GL) contract menu, which is based on the GL contract studied in Wang and Webster (2007) , is derived for the manufacturer (the principal) by mechanism design theory; (2) Under the MGL contract menu, information asymmetry lowers the production quantity, decreases the manufacturer's profit and deteriorates supply chain performance, while increasing the retailer's utility; (3) The MGL contract menu can coordinate the supply chain with asymmetric information in an implementable way if the wholesale price is endogenously determined by the manufacturer and its lower bound is 0.