Technical Note—Impact of Inventory on Quota-Bonus Contracts with Rent Sharing

Abstract

We study the impact of limited inventory on optimal sales-force compensation contracts. We adopt a principal-agent framework, characterized by limited liability and rent sharing with the agent. A commonly invoked assumption in the inventory management literature is that the demand distribution satisfies the increasing failure rate (IFR) property. Under this assumption, however, past research has established that a quota-bonus contract—a widely adopted sales-force compensation contract in the practice—cannot sustain in equilibrium. We show that because of demand censoring in the presence of limited inventory (i.e., demand realizations higher than the inventory level are unobservable), a quota-bonus contract is the optimal equilibrium contract, and it exists, even for a demand distribution with the IFR property. Since most well-known distributions satisfy the IFR property, and inventory constraints are operative in many real-world situations, our results significantly extend the scope of the optimality of quota-bonus contracts and underscore the importance of considering the inventory aspect while making sales-force compensation decisions.