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Efficient Supply Chain Contracting with Loss-averse Players in Presence of Multiple Plausible Breaches

Author

Listed:
  • Mitra, Arijit

    (Xavier Institute of Management Bhubaneswar (XIMB))

  • Sarkar, Sumit

    (XLRI-Xavier School of Management)

Abstract

The legal literature distinguishes between the liquidated damage and the penalty clauses in contracts, and holds that penalties designed for the prevention of breach are excessive compared to the liquidated damages. In an efficient supply chain contract, the penalty must satisfy the participation and incentive compatibility constraints of the signatories. Considering loss-averse players, we have calculated optimal penalties in a supply chain contract and compared those with the liquidated damages. Two possible breaches are considered – a breach in quality of the delivery and a breach in the process. In the absence of any penalty, a process breach reduces the supplier’s delivery risk and cost of delivery. Determining the parametric conditions for efficient contracts, numerically we show the effects of various variables on the zone of efficient contract. We show that the optimal penalties need not be excessive compared to the liquidated damages.

Suggested Citation

  • Mitra, Arijit & Sarkar, Sumit, 2022. "Efficient Supply Chain Contracting with Loss-averse Players in Presence of Multiple Plausible Breaches," American Business Review, Pompea College of Business, University of New Haven, vol. 25(2), pages 270-292, November.
    • Handle: RePEc:ris:ambsrv:0058
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    File URL: https://digitalcommons.newhaven.edu/americanbusinessreview/vol25/iss2/3/
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    More about this item

    Keywords

    Contract; Liquidated Damage; Loss-aversion; Penalty; Supply Chain;
    All these keywords.

    JEL classification:

    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation

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