Strategic risk in contract design

Abdolkarim Sadrieh and Guido Voigt ()

No 130005, FEMM Working Papers from Otto-von-Guericke University Magdeburg, Faculty of Economics and Management

Abstract: Supply chains facing asymmetric information can either operate in a cooperative mode with information and benefit sharing or can choose a non-cooperative form of interaction and align their incentives via screening contracts. In the cooperative mode, supply chain efficiency can be achieved, but high levels of trust and trustworthiness are required. In the non-cooperative mode, the contract mechanism guarantees a second best supply chain performance, but only if all parties choose their equilibrium strategies without trembles. Experimental evidence, however, shows that both operating modes often fail due to strategic risk. Cooperation is disrupted by deceptive signals and the lack of trust, whereas non-cooperative strategies suffer from persistent out-of-equilibrium behavior. We present an experiment on supply chain interaction with reduced strategic risk in both operating modes. We find that supply chain performance can reach a second-best level in either operating mode, if strategic risk is sufficiently reduced. We present two means to reduce strategic risk. First, a punishment mechanism leads to a better matching of trust and trustworthiness and supports the cooperative operating mode. Second, an enforcement of self-selection supports the non-cooperative equilibrium by increasing the attractiveness of screening contracts. We conclude that supply chain managers should seek to reduce the variability of the supply chain partners' behavior no matter what operating mode is considered.

Keywords: Behavioral operations management; contracting; asymmetric information; punishment (search for similar items in EconPapers)
Pages: 27 pages
Date: 2013-03
New Economics Papers: this item is included in nep-cta, nep-exp and nep-hrm
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Persistent link: https://EconPapers.repec.org/RePEc:mag:wpaper:130005

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