Guarding against Disruption Risk by Contracting under Information Asymmetry

• Published in: Decision sciences 2020-12, Vol.51 (6), p.1521-1559
• Main Authors: Li, Guo, Liu, Mengqi, Bian, Yiwen, Sethi, Suresh P.
• Format: Article
• Language: English
• Subjects: Asymmetric information; Asymmetry; Business schools; Contracting; Contracts; Decentralization; Disruption; Disruption Risk; Heterogeneity; Information Asymmetry; Logistics; Reliability; Reliability Enhancement; Risk; Screening; Screening Menu Contract; Suppliers; Supply; Supply chains; Transparency; Wholesale Price Contract
• ISSN: 0011-7315; 1540-5915
• DOI: 10.1111/deci.12437

ABSTRACT This study considers a decentralized supply chain in which a downstream manufacturer purchases a component from an upstream supplier privileged with private information on supply disruption risk. The supplier's initial reliability, asymmetric to the manufacturer, is either low or high. To guard against disruption risk by enhancing supply reliability, the manufacturer employs two representative contracts, namely, the wholesale price contract and the screening menu contract. We first examine the push and pull regimes under the wholesale price contract, and find that the manufacturer prefers the pull regime. Under the screening menu contract, we also consider two regimes: contracting the high‐type and low‐type supplier, and contracting only the high‐type supplier. From the perspective of the manufacturer, the regime that allows contracting both types of the supplier dominates the regime of contracting only the high‐type supplier under certain conditions. Comparing the wholesale price and screening menu contracts, we derive several interesting results. First, under specific conditions, the wholesale price contract is dominant for the manufacturer when the reliability enhancement cost or initial supply reliability heterogeneity is relatively high; otherwise, the screening menu contract is more favorable to the manufacturer. Second, in the pull regime, more information transparency may be detrimental to the manufacturer when the supplier's initial reliability is low, whereas the high‐type supplier can surprisingly yield a high profit under information asymmetry. Third, the low‐type supplier's preference on information transparency hinges on the reliability enhancement cost in the push regime.