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Browsing by Subject "Loss aversion"

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    Buyback versus revenue sharing contracts: the supplier's perspective
    (2013-07) Zhang, Yinghao
    Prior theory claims that buyback and revenue sharing contracts achieve equivalent channel-coordinating solutions when applied in a single supplier-buyer setting. This suggests that a supplier should be indifferent in choosing which contract to offer. However, the sequence and magnitude of costs and revenues (i.e., losses and gains) vary significantly between the two contracts, suggesting the supplier's preference of contract type, and associated contract parameter values, will vary with her level of loss aversion. We study this phenomenon from the supplier's perspective in three stages. First, we investigate whether human suppliers are indeed indifferent between these two equivalent contracts. Using a controlled laboratory experiment, with human subjects taking on the role of supplier having to choose between the two contracts, we find that contract preferences change with the ratio of overage and underage costs for the channel (i.e., the newsvendor critical ratio). In particular, a buyback contract is preferred for products with low critical ratio while revenue sharing is preferred for products with high critical ratio. We show that these results are consistent with the behavioral tendency of loss aversion and are more significant for subjects that exhibit higher loss aversion tendencies in an out of context task. Second, we examine differences in the performance of buyback and revenue sharing contracts when suppliers have the authority to set contract parameters. We find that the contract frame influences the way parameters are set and the critical ratio again plays an important role. More specifically, we find that in a high critical ratio environment revenue sharing contracts are more profitable for the supplier than buyback contracts while there is little difference in performance between the two contracts in a low critical ratio environment. We also find that adding prospective accounting tendencies into the behavioral model provides a stronger predictor of behavior in this setting than loss aversion alone. Finally, we discuss how a retailer's behavioral tendencies may influence the supplier's contract decisions and contract performance. We find that the existence of bounded rationality and rejection risk at the retailer level can significantly reduce the supplier's expected profit but do not influence the relative performance of buyback versus revenue sharing. However, judgment biases (due to loss aversion and prospective accounting) may increase the supplier's expected profit in some situations and the supplier is more profitable under buyback contracts. This research can help inform supply managers on what types of contracts should be used in different critical ratio environments.