Fairness and Coordination Failures in Supply Chain Contracts

Channel coordination using contracts is a topic that commanded a great deal of attention in the supply chain management literature. Several recent studies that tested the performance of coordinating contracts in the laboratory found that they fail to coordinate channels, and a major reason for this failure is that a significant proportion of offers are rejected. Our study extends the body of research on channel coordination by developing a new model based on fairness and bounded rationality, that aims to explain rejections. When fairness considerations are private information, we derive an optimal contract and characterize conditions in which this optimal contract implies rejections. Thus, our major finding is that when fairness considerations are private information, they may lead to rejections even when agents are fully rational.