Abstract
In environments of uncertainty risk sharing is often an important element of economic contracts. We consider a setting where a buyer and a risk-averse supplier contract for the production of some good under cost uncertainty. At the time of contracting, both parties have incomplete information on cost of production. However, after contracting and before production, the supplier can privately discover the realization of cost. We study the supply contract that optimally balances risk sharing and information revelation when the supplier is privately informed of its risk preference. We find that all types of supplier could produce either below or above the efficient supply schedule depending on the buyer’s risk preference. Moreover, "inflexible rules" rather than "discretion" arise for some range of cost realizations as a solution to the conflict between risk sharing and information revelation.
Comments
Discussion Paper 2009-03
JEL Classification: D81; D82; D86