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Stephen G. Leider- March 7, 2014

FACULTY ONLY: Meet with Steve during his visit to campus!
 Meeting signups are available at: http://doodle.com/mvzy5d537gyu37q8

Capacity Investment in Supply Chains: Contracts and the Hold-Up Problem (with Andrew Davis)

Suppliers are often reluctant to invest in capacity if they feel that they will be unable to recover their initial investment costs, in subsequent negotiations with buyers.  In theory, a number of different coordinating contracts can solve this form of hold-up problem and induce first best investment levels by the supplier.  In this study, we experimentally evaluate the performance of these contracts in a two-stage supply chain.  We employ a novel experimental design where retailers and suppliers bargain over contract terms, where both roles have the ability to make multiple back-and-forth offers while also providing feedback about the offers they receive.  

Our main result suggests that an option contract is best at increasing investment levels, and thus increasing overall supply chain profits.  Furthermore, after investigating the evolution of offers during bargaining, we observe that participants tend to place particular emphasis on ``superficial fairness.''  Specifically, participants focus more on setting a wholesale price that is in the middle of the available contracting space, while largely ignoring the coordinating contract parameter.  We show that this behavioral tendency drives the favorable performance of the option contract, as there is a large set of coordinating terms which, conditional on having a superficially fair wholesale price, generate the proper incentives for suppliers to invest, and thus increase the total expected surplus.

A few pictures from the seminar:

Feb 24, 2014, 2:16 PM