Optimal Retail Contracts with Asymmetric Information and Moral Hazard

Abstract:
Constrained joint-profit-maximizing retail contracts are derived when the dealer is privately informed about demand conditions before contracting with the manufacturer. Demand is increased by dealer promotion, which is unobservable by the manufacturer. Consequently, the manufacturer does not know whether to attribute a low level of sales to a decline in demand or to a lack of promotion. We show that, in general, the optimal contract exhibits some form of resale price maintenance and quantity fixing. The type of resale price maintenance and quantity fixing depends on how price and quantity affect the link between sales and promotion.