Carbon-reducing contract design for a supply chain with environmental responsibility under asymmetric information

Abstract Corporate environmental responsibility has received considerable attention, but how information asymmetry affects firms’ incentives in their fulfillment of environmental responsibilities and achievement of profitability has not yet been fully understood. In this paper, we consider a supply chain in which a manufacturer and a retailer invest in carbon-reducing technology and green-marketing efforts, respectively, to reduce carbon footprint. The main issue addressed here is how does the manufacturer design contracts to ensure profitability and compliance with environmental responsibilities when the retailer privately knows the extent of green-marketing efforts and the true market size. We develop contracting models for the decentralized supply chain and for the benchmark case in which the supply chain is vertically integrated. The results show that, in equilibrium, the optimal contract under full information ensures profitability and compliance with environmental responsibilities in that the system profit and the carbon footprint in the decentralized supply chain equal those in the integrated supply chain. Under asymmetric information, the manufacturer offers a menu of contracts to induce the retailer to disclose the true market size and to actively engage in carbon footprint reduction. In particular, the menu of contracts allows the manufacturer to obtain more profit with a lower carbon footprint, and enables the retailer to get extra information rent and therefore facilitates the fulfillment of environmental responsibility. Interestingly, the manufacturer may employ a cut-off policy to deter the retailer from contracting under some conditions. We reveal that the policy is always profitable for the manufacturer, whereas it may not be environmentally friendly. Furthermore, sensitivity analysis demonstrates that: (i) when the efficiency of carbon-reducing investment increases, the menu of contracts makes the manufacturer more profitable and results in a reduced carbon footprint as long as the efficiency becomes sufficiently high, and (ii) when the probability of a high market size increases or the carbon trading price rises, the menu of contracts increases the manufacturer’s profit and meanwhile decreases the carbon footprint, thus ensuring profitability and compliance with environmental responsibilities.