THE DESIGN OF SUPPLY CONTRACTS AS A PROBLEM OF DELEGATION

We consider the design of a supply contract as a problem of delegation in a buying firm. In general the agent (who acts on behalf of a principal in the firm) cannot be assumed to transform her information in probability estimates like the principal would do possessing the same information. In the investigated case of incomplete information the design of contracts is affected by the beliefs about characteristics of the supplier. Therefore it is important to analyze in which way the expected profit depends on these probabilities in order to find the principal's optimal instruction. The best instruction is determined by a trade-off between the costs due to the time the principal spends on dealing with the problem and formulating the instructions and the costs due to a suboptimal menu of contracts offered by the agent.