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

What is it about?

An efficient contract ensures that no party has any incentive to breach the clauses included in the contract. Breaches can result in a waste of resources and loss of reputation. In this paper we investigate how much penalty is required to make the contract efficient, when breaches might happen in quality and the signatories are loss-averse.

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Why is it important?

Supply-chain managers and practitioners in the field of operations and supply-chain management benefit from the following insights: • If the base payment is small, the supplier will not sign the contract unless the penalties charged upon a breach, are less than the corresponding liquidated damages. • If the buyer's value of the product that follows correct delivery and process is sufficiently high, a loss-averse supplier will not sign the contract unless the penalties are less than the corresponding liquidated damages. • If the buyer's value of the product following a standard process (i.e., not following the correct process) is sufficiently low, then a loss-averse supplier will not sign the contract unless the penalty due to process breach is less than the liquidated damage. • If the supplier's cost of following the correct process is sufficiently high, then they will not sign the contract unless the penalties for delivery and process breaches are less than the corresponding liquidated damages.

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