Designing a Revenue Sharing Contract under Information Asymmetry
01 Oct 2020-Vol. 5, Iss: 5, pp 820-834
TL;DR: In this paper, the authors investigate the impact of retailer's decisions on the subsequent choices made by the supplier in an audit-based revenue sharing contract and find that the audit probability of the supplier increases with the gap between retailer's order quantity and the sales reported by the retailer.
Abstract: In a supply chain coordinated by a revenue sharing contract, under-reporting of sales revenue has been a common practice amongst retailers who always have private information about the market demand. In this article, we aim to design a mechanism to mitigate this problem. One may design a contract to elicit truthful information from the retailer while maximizing supplier’s payoff. However, we find that such contracts fail to coordinate the supply chain, when the market demand is high. Hence, we study an audit-based revenue sharing contract. First, we design a laboratory experiment to investigate the impact of retailer’s decisions on the subsequent choices made by the supplier. We find that the audit probability chosen by the supplier increases with the gap between retailer’s order quantity and the sales reported by the retailer. We follow this up with a simulation experiment which incorporates the findings of our laboratory experiment. Audit cost and the penalty announced by the supplier for not reporting true sales turned out to be important in making decisions for both the players. We also find the threshold auditing cost beyond which auditing is not economically viable for the supplier. KeywordsSupply chain, Revenue sharing contract, Information asymmetry, Dishonesty.
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TL;DR: In this paper , a two-echelon supply chain comprising a supplier and a retailer, coordinated by a revenue-sharing contract has been studied, where the supplier uses audit probabilistically to check the retailer's dishonesty.
Abstract: A two-echelon supply chain comprising a supplier and a retailer, coordinated by a revenue-sharing contract has been studied. The supplier knows the realized demand only from a sales report submitted by the retailer at the end of each decision period. Possession of private information about the market demand allows the retailer to under-report sales. To protect revenue loss from this under-reporting, the supplier uses audit probabilistically to check the retailer’s dishonesty. Unlike designing a mechanism for the supplier to elicit private information from the retailer, which has been predominantly discussed in the literature, this study proposes a policy where the players can improve their expected profit compared to what they would have earned when the retailer had to reveal truthful information. Our study finds that the supplier benefits from the retailer’s dishonesty, provided dishonesty is limited with the help of a probabilistic audit process. Both players' expected profits are higher in our proposed policy than what they would earn under a truth-inducing policy. These findings suggest that future studies focus on achieving social welfare instead of concentrating only on truth-inducing mechanisms. A numerical analysis of the optimization problem is performed to find the optimal audit probability. Our results will help a manager in a supplying firm design a revenue-sharing contract when she cannot observe her retailer’s revenue without an audit.
References
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TL;DR: In this article, the authors focus on avoidable moral hazard and offer one explanation for limited insurance markets, for closely held firms, and for seemingly simple as opposed to contingent forms of debt.
2,713 citations
"Designing a Revenue Sharing Contrac..." refers background in this paper
...As discussed earlier, auditing is predominant in the tax evasion scenario (Townsend, 1979; Sandmo, 2005 etc.)....
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TL;DR: Several limitations of revenue sharing are identified to (at least partially) explain why it is not prevalent in all industries, including cases in which revenue sharing provides only a small improvement over the administratively cheaper wholesale price contract.
Abstract: Under a revenue-sharing contract, a retailer pays a supplier a wholesale price for each unit purchased, plus a percentage of the revenue the retailer generates. Such contracts have become more prevalent in the videocassette rental industry relative to the more conventional wholesale price contract. This paper studies revenue-sharing contracts in a general supply chain model with revenues determined by each retailer's purchase quantity and price. Demand can be deterministic or stochastic and revenue is generated either from rentals or outright sales. Our model includes the case of a supplier selling to a classical fixed-price newsvendor or a price-setting newsvendor. We demonstrate that revenue sharing coordinates a supply chain with a single retailer (i.e., the retailer chooses optimal price and quantity) and arbitrarily allocates the supply chain's profit. We compare revenue sharing to a number of other supply chain contracts (e.g., buy-back contracts, price-discount contracts, quantity-flexibility contracts, sales-rebate contracts, franchise contracts, and quantity discounts). We find that revenue sharing is equivalent to buybacks in the newsvendor case and equivalent to price discounts in the price-setting newsvendor case. Revenue sharing also coordinates a supply chain with retailers competing in quantities, e.g., Cournot competitors or competing newsvendors with fixed prices. Despite its numerous merits, we identify several limitations of revenue sharing to (at least partially) explain why it is not prevalent in all industries. In particular, we characterize cases in which revenue sharing provides only a small improvement over the administratively cheaper wholesale price contract. Additionally, revenue sharing does not coordinate a supply chain with demand that depends on costly retail effort. We develop a variation on revenue sharing for this setting.
2,271 citations
"Designing a Revenue Sharing Contrac..." refers background in this paper
...An implicit assumption in the classical revenue sharing contract (Cachon and Lariviere, 2005) is that the retailer always reports the actual revenue....
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...In case of a coordinated supply chain under a revenue sharing contract, the optimal ordered quantity by a retailer satisfies the condition 𝐹(𝑄) = 𝑟−𝑐 𝑟 where the supplier’s decision satisfies the relation 𝑤 = (1 − α)𝑐 (Cachon and Lariviere, 2005)....
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...Effect of an Audit in a Revenue Sharing Contract: Experimental Study An implicit assumption in the classical revenue sharing contract (Cachon and Lariviere, 2005) is that the retailer always reports the actual revenue....
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...In case of a coordinated supply chain under a revenue sharing contract, the optimal ordered quantity by a retailer satisfies the condition F(Q) = r−c r where the supplier’s decision satisfies the relation w = (1 − α)c (Cachon and Lariviere, 2005)....
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Posted Content•
TL;DR: The authors investigate how external and internal rewards work in concert to produce (dis)honesty and suggest that dishonesty governed by self-concept maintenance is likely to be prevalent in the economy, and understand it has important implications for designing effective methods to curb dishonesty.
Abstract: Dishonesty plays a large role in the economy. Causes for (dis)honest behavior seem to be based partially on external rewards, and partially on internal rewards. Here, we investigate how such external and internal rewards work in concert to produce (dis)honesty. We propose and test a theory of self-concept maintenance that allows people to engage to some level in dishonest behavior, thereby benefiting from external benefits of dishonesty, while maintaining their positive view about themselves in terms of being honest individuals. The results show that (1) given the opportunity to engage in beneficial dishonesty, people will engage in such behaviors; (2) the amount of dishonesty is largely insensitive to either the expected external benefits or the costs associated with the deceptive acts; (3) people know about their actions but do not update their self-concepts; (4) causing people to become more aware of their internal standards for honesty decreases their tendency for deception; and (5) increasing the "degrees of freedom" that people have to interpret their actions increases their tendency for deception. We suggest that dishonesty governed by self-concept maintenance is likely to be prevalent in the economy, and understanding it has important implications for designing effective methods to curb dishonesty.Former working paper titles:“(Dis)Honesty: A Combination of Internal and External Rewards” and "Almost Honest: Internal and External Motives for Honesty")
2,056 citations
"Designing a Revenue Sharing Contrac..." refers background in this paper
...Impact of various factors have been studied, viz. monitoring (Fischbacher and Follmi-Heusi, 2013; Schweitzer et al., 2016, etc.); incentives (Mazar et al., 2008; Gill et al., 2013, etc.)....
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TL;DR: The authors show that people behave dishonestly enough to profit but honestly enough to delude themselves of their own integrity, and that a little bit of dishonesty gives a taste of profit without spoiling a positive self-view.
Abstract: People like to think of themselves as honest. However, dishonesty pays—and it often pays well. How do people resolve this tension? This research shows that people behave dishonestly enough to profit but honestly enough to delude themselves of their own integrity. A little bit of dishonesty gives a taste of profit without spoiling a positive self-view. Two mechanisms allow for such self-concept maintenance: inattention to moral standards and categorization malleability. Six experiments support the authors' theory of self-concept maintenance and offer practical applications for curbing dishonesty in everyday life.
1,756 citations
1,383 citations
"Designing a Revenue Sharing Contrac..." refers methods in this paper
...ANOVA turned out to be significant (𝐹(3,112,0.05) = 19.903, 𝑝 = .000)....
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...Hence, we performed Welch’s ANOVA (Welch, 1951) followed by Games-Howell post-hoc test (Games and Howell, 1976)....
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...We performed one-way ANOVA test among these buckets of Suspect Ratio with average number of audits per month as the dependent variable....
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