Supply chain contracting with asymmetric cost information and behavioral preferences: Theory and experiment

We investigate a supply chain composed of a retailer who designs a contract with wholesale price and order quantity, and a supplier who has private information of low or high unit production cost. The standard benchmark predicts that in equilibrium, the optimal contract possesses a threshold dividing a cutoff condition and a non-cutoff condition for the retailer. Under the cutoff condition, retailers trade only with low-cost suppliers, while under the non-cutoff condition, retailers trade with both low-cost and high-cost suppliers. Suppliers accept the critical non-negative profit contracts. We incorporate behavioral factors of the retailer's risk preference and the supplier's fairness concern in view of the decision-making scenario. The behavioral model shows that the risk preference influences the threshold of the optimal contract design, while the fairness concern only affects the optimal wholesale price. We conduct a laboratory experiment to examine both parties' decision behaviors and find that human retailers with risk-averse preference make local optimal strategies rather than global optimal strategies, which counter-intuitively improves the channel profit; and human suppliers with fairness concern enables human retailers to provide fair contracts, which increases the channel profit and balances the channel profit distribution. These findings imply that the behavior of retailers and suppliers plays an important role in mechanism design of supply chains.