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Title: Optimal contracting with a fair-minded retailer

Authors: Elena Katok and Valery Pavlov

Abstract:

Operations management literature proposes many different contracts to coordinate a simple supplier-retailer channel. Generally, when these contracts are tested in a laboratory setting they do not work as the standard theory predicts: the supplier, even when endowed with all the bargaining power, is able neither to fully coordinate the channel nor to extract all of the channel profit. This is consistent with the existing data on the Ultimatum Game experiments, which are similar to contracting games studied in the supply chain literature. We extend the existing body of research in supply chain coordination by providing a model that incorporates the desire for fairness into the supply chain contracting setting, and characterize the supplier's optimal profit-maximizing contract when faced with a retailer who demands her fair share. We test the model using a laboratory experiment and find that it explains and predicts contracting outcomes significantly better than the standard theory.