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Contracting with Private Knowledge of Production Capacity

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  • Leon Yang Chu
  • David E. M. Sappington

Abstract

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.

Suggested Citation

  • Leon Yang Chu & David E. M. Sappington, 2015. "Contracting with Private Knowledge of Production Capacity," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 24(4), pages 752-785, October.
    • Handle: RePEc:bla:jemstr:v:24:y:2015:i:4:p:752-785
    DOI: 10.1111/jems.12112
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    References listed on IDEAS

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    Cited by:

    1. Bin Hu & Anyan Qi, 2018. "Optimal Procurement Mechanisms for Assembly," Manufacturing & Service Operations Management, INFORMS, vol. 20(4), pages 655-666, October.
    2. Ehsan Bolandifar & Tianjun Feng & Fuqiang Zhang, 2018. "Simple Contracts to Assure Supply Under Noncontractible Capacity and Asymmetric Cost Information," Manufacturing & Service Operations Management, INFORMS, vol. 20(2), pages 217-231, May.

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