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Contracting with Private Knowledge of Production Capacity
Author(s) -
Chu Leon Yang,
Sappington David E. M.
Publication year - 2015
Publication title -
journal of economics and management strategy
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.672
H-Index - 68
eISSN - 1530-9134
pISSN - 1058-6407
DOI - 10.1111/jems.12112
Subject(s) - production (economics) , procurement , incentive , business , unit (ring theory) , reimbursement , simple (philosophy) , microeconomics , industrial organization , economics , marketing , health care , philosophy , mathematics education , mathematics , epistemology , economic growth
We analyze the design of procurement contracts when the supplier is privately informed about both his innate production capacity ( K ) and his innate unit cost of production. We identify conditions under which the supplier will strategically employ an inefficient production technology to expand output above K . We also show that when the buyer employs the simple fixed‐price cost‐reimbursement (FPCR) contracts in the setting examined by Rogerson (2003), the supplier has no incentive to exaggerate K . Furthermore, the buyer can secure with FPCR contracts at least 75% of the surplus she secures with fully optimal contracts.
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