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Inequity aversion in a joint economic lot sizing environment with asymmetric holding cost information

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  • Guido Voigt

    (Otto von Guericke Universitat, Magdeburg, Germany)

Abstract
Screening contracts (or ‘menu of contracts’) are frequently used for aligning the incentives in supply chains with private information. In this context, it is assumed that all supply chain parties are strictly (expected) profit-maximizing. However, previous empirical work shows that this is a critical assumption. In fact, it seems that inequity adverse subjects are willing to invest money for achieving higher relative payoffs. Interestingly, the classical approach to design incentive compatible mechanisms gives the agent cheap leeway to increase relative pecuniary payoffs and thereby achieving more equitable profit allocations, because the agent is left (almost) indifferent between two contract alternatives. In other words, we argue (and actually observe in laboratory experiments) that this classical approach of contract design allows the agent to achieve more equitable outcomes at low cost. Since the agent’s better relative performance solely stems from reducing the principal’s payoffs, we observe a substantial negative impact on the overall supply chain performance. The present work relaxes the assumption of the profit-maximizing buyer (agent) in a serial supply chain for a lot sizing framework with asymmetrically distributed holding cost information and deterministic end-customer demand. The study provides researchers and managers an approach on how to account for disadvantageous inequity aversion (ie, the agent suffers from profits being lower than the principals profits) by designing a contract that anticipates such behaviour while providing a solution method for the resulting non-linear mathematical program. We denote the resulting contract as ‘behavioural robust’, since it limits the inefficiency losses that result if agents exhibit disadvantageous inequity aversion instead of being strictly profit-maximizing. A numerical study compares the advantages of the ‘behavioural robust’ contract against the classical screening contract. The results highlight that supply chain performance losses can be substantially reduced under the behavioural robust contract.

Suggested Citation

  • Guido Voigt, 2015. "Inequity aversion in a joint economic lot sizing environment with asymmetric holding cost information," Journal of the Operational Research Society, Palgrave Macmillan;The OR Society, vol. 66(4), pages 554-569, April.
  • Handle: RePEc:pal:jorsoc:v:66:y:2015:i:4:p:554-569
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    Cited by:

    1. Kerkkamp, R.B.O. & van den Heuvel, W. & Wagelmans, A.P.M., 2018. "Two-echelon supply chain coordination under information asymmetry with multiple types," Omega, Elsevier, vol. 76(C), pages 137-159.
    2. Abdolkarim Sadrieh & Guido Voigt, 2017. "Strategic risk in supply chain contract design," Journal of Business Economics, Springer, vol. 87(1), pages 125-153, January.
    3. Martin Albrecht, 2017. "Coordination of dynamic lot-sizing in supply chains," Journal of the Operational Research Society, Palgrave Macmillan;The OR Society, vol. 68(3), pages 322-330, March.

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