Asymmetric Information Costs Research Articles

Should competing original equipment manufacturers outsource procurement activities under asymmetric cost information?

This paper considers a supply chain in which two competing heterogeneous original equipment manufacturers (OEMs) outsource production to a common contract manufacturer (CM) that possesses private cost information. Along with production outsourcing, the OEMs can either purchase components by themselves and only assign the production tasks to the CM (Consignment), or delegate both the procurement and production tasks to the CM (Turnkey). The main question we address is whether the OEMs should adopt Consignment or Turnkey. To answer this question, we first analyse the OEMs’ optimal mechanism design problems under three scenarios: both OEMs adopt Consignment strategy; both OEMs adopt Turnkey strategy; one OEM adopts Consignment and the other one adopts Turnkey. Building upon the OEMs’ equilibrium decisions under each scenario, we then characterise the equilibrium outcome for the procurement game. The results show that the CM’s procurement cost distribution and the market size play critical roles in the equilibrium outcome. Additionally, we find that both the competition intensity and cost heterogeneity between the OEMs affect the equilibrium outcome.

Contract design in reverse recycling supply chain with waste cooking oil under asymmetric cost information

Waste cooking oil without proper treatment brings serious environmental and health hazards, which can be mitigated by converting waste cooking oil into bio-fuel. In a supply chain of waste cooking oil recycling, an independent recycler collects waste cooking oil and trades with a bio-firm who carries out conversion to produce bio-fuel and then get profit. Since the unit recycling cost of the recycler remains private, this paper compares two possible contracting mechanisms for the bio-firm, a principal-agent contract or a quantity discount contract, to deal with such information asymmetry or stimulate the recycler's recycling investment. Optimal contract settings for the bio-firm and the recycler's response of recycling investment level are derived. Also, each firm's contract preferences are investigated. Main results indicate that when the average recycling cost or the uncertainty level of cost information is relatively low, the bio-firm is better off to choose a quantity discount contract while the recycler prefers the principal-agent contract. If either factor is of a moderate level, the quantity discount contract dominates by benefiting both the bio-firm and the low-cost recycler. With either high average cost or uncertainty level, the bio-firm and the high-cost recycler would welcome a principal-agent contract. Besides, the principal-agent contract induces more waste cooking oil to be recycled and is more environmental-friendly than the quantity discount contract.

Newsvendor competition under asymmetric cost information

We study the newsboy duopoly problem under asymmetric cost information. We extend the Lippman and McCardle (1997) of competitive newsboy to the case where the two firms are privately informed about their unit costs. The market demand is initially split between two firms and the excess demand for each firm is reallocated to the rival firm. We show the existence and uniqueness of a pure strategy equilibrium and characterize its structure. The equilibrium conditions have an interesting recursive structure that enables an easy computation of the equilibrium order quantities. Presence of strategic interactions creates incentives to increase order quantities for all firm types except the type that has the highest possible unit cost. Consequently, competition leads to higher total inventory in the industry. However, contrary to intuition, this is only true when the firms are non-identical. A firm’s equilibrium order quantity increases with a stochastic increase in the total industry demand or with an increase in his initial allocation of the total industry demand. We demonstrate our model and results in an application in a dual-sourcing procurement setting using data that obtained from a large manufacturing company. Finally, we provide a full characterization of the equilibrium of the game for the special case of uniform demand and linear market shares.

Dealer Inventory, Short Interest and Price Efficiency in the Corporate Bond Market

We propose an equilibrium model of over-the-counter corporate bond trading with short selling, asymmetric information and dealer inventory costs. The model predicts that higher inventory costs impose implicit short-sale constraints on informed investors and are thus associated with lower price efficiency. We construct bond-level proxies for inventory costs and provide empirical evidence in support of the model’s prediction. Our findings suggest that tighter post-GFC regulation may have had unintended consequences for corporate bond market quality.

Self-Regulation Under Asymmetric Cost Information

In this paper, we study how a monopolistic firm with unknown costs may behave under the threat of regulation. To this aim, we integrate the self-regulation model of Glazer and McMillan (1992) with the optimal regulatory mechanism devised by Baron and Myerson (1982) for the case of asymmetric information. Simulating the equilibrium outcome of our integrated model for a wide range of parameter values, we show that the firm threatened with regulation always constrains its price; moreover, it does so more stringently if it is less efficient. If the marginal cost of the firm is sufficiently close to the highest possible value according to the beliefs of the legislators and the regulator, the price the firm charges under the threat of regulation can be even lower than the price it has to charge when it is regulated. Our simulations also reveal how the welfares of consumers and the threatened firm may be affected in the short-run and long-run by possible variations in several attributes of our model, involving the marginal cost of production, the number of legislators, each legislator's cost of proposing a regulatory bill, the size of the market, and the weight of the firm's welfare in the social welfare function.

The components of the bid‐ask spread: Evidence from the corn futures market

AbstractThis article examines whether USDA announcements and commodity index fund rolling activity have an impact on liquidity costs, measured by the bid‐ask spread. Using Huang and Stoll's (1997) model of liquidity costs, we estimate whether changes to liquidity costs are driven by its adverse selection, inventory, or order processing components. Commodity index fund roll activity reduces the asymmetric information cost component of liquidity cost due to an increased proportion of noninformation‐based trading, but the inventory cost component increases as (mostly long only) commodity index funds sell their nearby positions and buy the first deferred contract—raising liquidity providers’ risk of building a position. The sum of these two effects is that liquidity costs remain low during index fund roll periods, averaging one “tick” (0.25 cents). On USDA report release days, we find that informed traders raise the asymmetric information component of liquidity costs in the first hour after release, but the inventory cost component is reduced due to the increase in volume. Similar to index fund roll activity, liquidity costs on USDA report release days remain low, averaging one “tick”. Our findings that liquidity costs are minimally changed during USDA report releases and commodity index fund roll periods is consistent with other recent research on liquidity costs, but we show that what drives liquidity costs differs substantially depending on the circumstances surrounding daily trading.

Does reputation matter in the dividend smoothing policy of emerging market firms? Empirical evidence from India

Integrating reputational considerations in the analysis of dividend smoothing, we study the dividend smoothing determinants. We examine the extent to which the asymmetric information and agency costs theories explain dividend smoothing and whether their proxies' impact varies given the firm's reputation as a high- or low-smoothing firm. Our quantile regression results confirm that the determinants vary significantly across smoothing quantiles. In the low-smoothing quantiles, capturing firms with a lower tendency towards smoothing and hence facing lesser or no reputational concerns, the degree of dividend smoothing increases significantly with size, age, and tangibility, whereas it declines with ownership concentration and risk. Interestingly, most of these factors turn insignificant for firms in the high-smoothing quantiles, facing higher reputational stakes. Emphasizing the predominance of reputational effects on the determination of dividend smoothing, these findings help explain the dividend smoothing puzzle: why firms with lesser or no need for dividend smoothing still smooth high.

Strategic procurement outsourcing with asymmetric cost information under scale economies

This paper considers a supply chain in which an original equipment manufacturer (OEM) outsources her production to a contract manufacturer (CM). For the product’s component, the OEM can either control the component procurement (i.e., control strategy), or delegate this work to the CM (i.e., delegation strategy). Meanwhile, they have different discount abilities for the procurement cost due to scale economies. Moreover, the CM’s discount ability is private information for himself. In the scenario where a non-competitive CM doesn’t have own brand products, the control strategy is superior to the delegation strategy for the OEM. In contrast, when the CM is competitive (with own brand production ability), the delegation strategy is optimal. This result is interesting and implies that the OEM prefers to adopt the delegation strategy because of the discount sharing effect, although the CM has private information in this case. Finally, the results of numerical simulation show that the CM’s competition can create a win–win situation under some certain conditions.

Optimal contract design for dual-channel supply chains under information asymmetry

PurposeThe aim of this paper is to investigate the effect of information asymmetry on revenue sharing contracts and performance in a dual-channel supply chain. First, the authors model the optimum revenue sharing contract in a dual-channel supply chain under both the full information case and the asymmetric information case. Second, they contrast the optimal decisions of a dual-channel supply chain between the full information case and the asymmetric information case. Third, they explore the impact of asymmetric cost information on the performance of a dual-channel supply chain and investigate the information value.Design/methodology/approachThe authors present two main issues associated with revenue sharing contracts to alleviate manufacturer–retailer conflicts in a dual-channel supply chain. In the first issue, a revenue sharing contract is designed in a dual-channel supply chain under asymmetric cost information conditions, based on the principal-agent model. In the second issue, an optimal revenue sharing contract under full information conditions, based on the Stackelberg game is discussed. They explore the impact of asymmetric cost information on the performance of a dual-channel supply chain and investigate the information value based on comparative static analysis.FindingsFirst, the direct sale price is unchanged and independent of the retailer’s cost construct, but the wholesale price increases and the retail sale price does not decrease under asymmetric cost information. The information asymmetry leads to higher direct sale demand and lower retail sale demand. Second, information asymmetry is beneficial for the retailer, but imposes inefficiency on the manufacturer and the whole supply chain. Third, the performance of the dual-channel supply chain is improved if the retailer’s cost information is shared and the dual-channel supply chain reaches coordination. The retailer is willing to share its cost information if the lump sum side payment that the manufacturer offers can make up the retailer’s reduced profit due to sharing this information.Originality/valueThe authors proposed a contract menus design model in a dual-channel supply chain. They examine how information asymmetry affects optimal policies and performance. They compared the optimal policies under symmetric information and asymmetric information. Conditions under which the partners prefer sharing information are identified. They quantified the information value from the points of partners and the whole system.

P.7.e.001 - Effects of traumatic experiences on suicidal ideation among Korean adolescents: the roles of depression and self-esteem

We study the newsboy duopoly problem under asymmetric cost information. We extend the Lippman and McCardle (1997) of competitive newsboy to the case where the two firms are privately informed about their unit costs. The market demand is initially split between two firms and the excess demand for each firm is reallocated to the rival firm. We show the existence and uniqueness of a pure strategy equilibrium and characterize its structure. The equilibrium conditions have an interesting recursive structure that enables an easy computation of the equilibrium order quantities. Presence of strategic interactions creates incentives to increase order quantities for all firm types except the type that has the highest possible unit cost. Consequently, competition leads to higher total inventory in the industry. However, contrary to intuition, this is only true when the firms are non-identical. A firm’s equilibrium order quantity increases with a stochastic increase in the total industry demand or with an increase in his initial allocation of the total industry demand. We demonstrate our model and results in an application in a dual-sourcing procurement setting using data that obtained from a large manufacturing company. Finally, we provide a full characterization of the equilibrium of the game for the special case of uniform demand and linear market shares.

Liquidity and realized volatility in short‐term interest rate futures in 2008 crisis

AbstractThe literature on derivative securities evidently does not contain any empirical studies of liquidity and volatility with high‐frequency data for leading Australian financial futures contracts, during the general financial crisis. Moreover, while the extant literature has studied the liquidity interdependence between spot markets for bonds and equities, the liquidity interdependence between the futures markets for these securities has been neglected. This article, in addressing these deficiencies, estimates the relationship between liquidity and realized volatility, for Australian 90 Day Bank Accepted Bills (BAB) futures (first interest rate futures contract outside USA), with high‐frequency data from the crisis year 2008, and studies the effect of changes in liquidity of S&P200 Index futures on the liquidity of BAB futures. The main results are first, the key variables are positively skewed and leptokurtic. Second, the ask–bid spread for BAB futures varies directly with volatility, which is consistent with a private information interpretation of volatility, which increases asymmetric information costs. Third, the ask–bid spreads for BAB futures and S&P200 futures exhibit positive covariation, which is consistent with the view of commonality in liquidity. The results of this research will be relevant to policymakers, regulators, market participants, educators, and graduate students.

Simple Contracts to Assure Supply Under Noncontractible Capacity and Asymmetric Cost Information

This paper studies a global sourcing problem where a buyer sources a product from a supplier to satisfy uncertain market demand. With the increasing length and complexity of today’s global supply chains, the buyer may face two issues when designing the sourcing contract: adverse selection (i.e., the supplier’s cost structure is private information) and noncontractible capacity (i.e., the supplier’s capacity investment is not contractible). We show that noncontractible capacity does not necessarily lead to a lower profit for the buyer, but it may require a more complex contract format to achieve the optimal (second-best) profit. Interestingly, we find that a single, linear contract (or a two-part tariff) could be optimal for the buyer under certain conditions. Even when such a contract is suboptimal, it can deliver close-to-optimal profit for the buyer for a wide range of situations. These findings indicate that the value of using a complex menu of contracts is negligible in such a supply chain setting. A simple two-part tariff is an attractive option for buyers whose goal is to ensure supply while facing both cost uncertainty and contractibility issues. The paper also provides a new explanation for the prevalence of such simple contracts in practice. The online appendix is available at https://doi.org/10.1287/msom.2017.0628 .

Global markets for technology: Evidence from patent transactions

The paper analyses the recent evolution of international markets for technology by examining changes in ownership of US granted patents. We study the effects of the geographical origin of patents, proxied by their first priority country, on the probability of patents being traded, on the timing of the transaction and on the probability of observing a cross-border transaction, while controlling for the characteristics of the patents, the time and sector specificities. The analyses are based on a comprehensive dataset that covers all the patents granted by the USPTO over the 2002–2012 period. The data from the US patent reassignment database have been cleaned and processed and a subset of 95,542 granted patents that have been traded has been identified. We obtain evidence from survival models that there has been an increase in the rate of patent transactions in recent years. The obtained results indicate that patents with a first non-US original applicant have less probability of being traded and show a longer time to transaction than US first priority patents. We also find that more science-based patents, which are usually characterized by a higher technological uncertainty, are more likely to be traded, but are much less likely to be involved in cross-border deals. The results are discussed in light of the impact of asymmetric information and search costs on international patent transactions.

Determinants of bank\u2019s financing choices under capital regulation

This paper analyzes the financing choices of banks under capital regulation during the expansion period that preceded the crisis. We use data from Dealogic on the issuances of financial instruments of Spanish banks to test whether financing choices respond to predictions derived from the corporate finance theory and/or to capital regulation. We find that banks financed their exponential growth with debt instruments and covered the additional regulatory capital requirements from higher risk-weighted assets with the issuance of hybrid instruments. We also find that banks choose the financial instruments that minimize asymmetric information costs.

Corporate Pensions and the Maturity Structure of Debt

AbstractIn this article, we investigate the role of pension obligations, the most significant off‐balance‐sheet item, in determining corporate debt maturity and spreads. We begin by showing a significant and robust positive relationship between pension liabilities and corporate short‐term debt ratio. We also find that more pension obligations cause a significant increase in the cost of debt, but this effect is mitigated by short‐maturity debt. Overall, our study shows that short‐term debt can reduce asymmetric information costs related to pensions.

Dealer Spreads in the Corporate Bond Market: Agent vs. Market-Making Roles

Utilizing subsets of trades in which dealers act purely as agents, purely as market-makers, and as both, we decompose dealer spreads in U.S. corporate bond OTC markets into components arising from: 1) dealers’ marketmaking role, and 2) their role as agents for their non-dealer customers. We find that agent-related spreads are large and comparable in magnitude to market-making spreads. In their role as agents, dealers face liquidity-search and customer interface costs, while in their role as market makers they face inventory and asymmetric information costs. Consistent with this, we find that while market-making spreads are strongly correlated with market risk variables, agent-related spreads are not, depending instead on liquidity driven variables. While market-making spreads are inversely related to trade size, agent-related spreads increase with trade size before leveling off and then declining -- possibly indicating that agent-dealers devote less search time to relatively small trades. Market makers trade both with dealers functioning as agents and directly with investors; our evidence indicates that market makers derive an information benefit from direct interaction with traders especially when risk and information asymmetry is high. Except for very small trades, explicit transaction costs of non-dealer customers are lower when they trade directly with market-making dealers than when they route trades through a dealer acting purely as an agent. Our evidence indicates that bond traders tend to employ agent-dealers when the cost of the agent is low relative to the trader’s internal search costs. Finally, we show that many existing studies have underestimated average overall trading costs in the corporate bond market by failing to account for both the agentdealer spread and market-making dealer spread on trades which involve both. Given our findings on the size and economic determinants of agent-related dealer costs, our results have significant implications for the extensive empirical literature on dealer spreads in other OTC markets.

Outsource planning with asymmetric supply cost information through a menu of option contracts

AbstractThis paper investigates a supply contract design by a dominant manufacturer who faces a stochastic demand during a selling season. The manufacturer has several estimations of the supplier's cost with corresponding probabilities, that is, asymmetric cost information. The manufacturer designs a menu of call option contracts that include three variables: a supply order, an option, and an exercise price. We determine the optimal negative correlation between option and exercise prices as well as closed‐form formulas for the optimal supply orders. The results show that in the optimal menu of contracts either the option or the exercise price may be omitted from the menu, whereas the supply orders should always be customized for each supplier type. We show that in this problem, optimal profit assignment between contract partners under put and bidirectional option contracts is the same as call option contract studied. Numerical analysis including managerial insights is presented.

Pricing and Design of After-Sales Service Contract: The Value of Mining Asymmetric Sales Cost Information

In this paper, we study a pricing and after-sales service contract design problem, where a retailer purchases products from a manufacturer and then sells to the consumers. The sales cost is the retailer’s private information and might be mined by the manufacturer via advanced learning algorithms and related big data techniques. We first develop a crisp equivalent model, based on which the optimal contracts and the supply chain parties’ profits under asymmetric information are derived. We show that, compared with the optimal wholesale price and after-sales service level with symmetric information, asymmetric cost information makes the wholesale price distorted upward when the retailer’s sales cost is low. When the retailer’s cost is high, the after-sales service level is distorted downward. We characterize the manufacturer’s loss and the retailer’s gains due to asymmetric sales cost information. This helps the manufacturer make the investment decision of big data techniques. Interestingly, we find that the retailer might voluntary disclose the sales cost information, which results in a win-win situation for the manufacturer and the retailer. This makes the manufacturer less favor big data techniques. Finally, we conduct extensive sensitivity analysis with respect to the retailer’s sales cost, the consumer’s sensitivity to the retailer’s after-sale service level, and the fraction of high-type retailers in the market.

Corporate Pensions and the Maturity Structure of Debt

In this paper, we investigate the role of pension obligations, the most significant off-balance-sheet item, in determining corporate debt maturity and spreads. We begin by showing a significant and robust positive relationship between pension liabilities and corporate short-term debt ratio. We also find that more pension obligations cause a significant increase in the cost of debt, but this effect is mitigated by short-maturity debt. Overall, our study shows that short-term debt can reduce asymmetric information costs related to pensions.

Buying up the Block: An Experimental Investigation of Capturing Economic Rents Through Sequential Negotiations*

This article analyzes an economic experiment designed to measure the effect of “legal technology” on the economic efficiency of Coasian bargaining. In the experiment, the agreement of many agents (called “landowners”) to transfer their property rights to a single agent (called “the developer”) generates an economic surplus. In this setting, we show that a very primitive legal technology sequential cash purchase (SC-P) is a strong implementation of a unique efficient bargaining outcome as a subgame perfect equilibrium. However, when deployed in the laboratory, SC-P results in an average loss of 60% of the economic surplus through inefficient negotiation failure. Deploying a more behaviorally robust but also more legally complex technology, a tender and conditional offer (TC-O) mechanism, halved the surplus loss and supported significant developer payoffs. These results suggest that, even absent asymmetric information, moral hazard, and transactions costs, complex legal technologies can increase bargaining efficiency.