Incentive contract design for reducing carbon emissions in the supply chain under asymmetric information

Abstract In light of the volatility of market demand and carbon trading prices, this study examines the effects of two carbon policies—the carbon tax policy and the cap‐and‐trade policy—as well as various information structures on the supply chain's carbon emission reduction incentives. A brand incentivizes the carbon abatement effort of an upstream supplier through a two‐part contract in the form of a fixed salary and a proportional incentive. We discover that, under some circumstances, the brand may benefit more from the unobservability of supply chain information. The brand bundles the risk of uncertainty with the supplier through the proportional incentive. In classical incentive contracts, only the cost is considered and the positive effect of risk conveyance is often ignored. In our study, the brand needs to investigate a trade‐off between the benefit of risk conveyance and the drawback of the incentive cost. On one hand, the proportional incentive characterizes the incentive cost. The brand increases the incentive intensity due to the unobservable effort of the supplier. On the other hand, it also has a risk conveyance effect. Specifically, the proportional incentive decreases with the correlation coefficient under the cap‐and‐trade policy. Additionally, there are situations in which consumer surplus benefits from the observability of supply chain information. However, supply chain information transparency is harmful to consumer surplus as supplier risk aversion increases.