Optimal Retail Contracts with Return Policies

38 Pages Posted: 20 Aug 2016 Last revised: 19 Sep 2023

See all articles by Ying-Ju Chen

Ying-Ju Chen

Hong Kong University of Science & Technology (HKUST) - Department of Information Systems, Business Statistics and Operations Management

Zhengqing Gui

National University of Singapore (NUS) - Risk Management Institute

Ernst-Ludwig von Thadden

Universitaet Mannheim; Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI)

Xiaojian Zhao

Monash University - Department of Economics

Date Written: April 5, 2021

Abstract

A central problem in vertical relationships is to minimize the mismatch between supply and demand. This paper studies a problem of contracting between a manufacturer and a retailer who privately observes the retail demand materialized after the contracting stage. Cash payments are bounded above by the retailer’s revenue, while the return of unsold inventories is bounded above by the order quantity net of the actual quantity sold. While the majority of the papers in the literature takes the contractual forms as given and investigates the consequences that these contracts may lead to in various contexts, without assuming any functional form of contracts, we show that the optimal contract can be implemented by a buy-back contract: the manufacturer requests an upfront payment from the retailer and buys back the unsold inventories at the retailer’s salvage value. The optimality of buy-back contracts is robust to several scenarios including competition between retailers.

Keywords: Retail contracts, return policies, buy-back contracts, incentive problems, limited liability

JEL Classification: D82, D86, L42, L60

Suggested Citation

Chen, Ying-Ju and Gui, Zhengqing and von Thadden, Ernst-Ludwig and Zhao, Xiaojian, Optimal Retail Contracts with Return Policies (April 5, 2021). Available at SSRN: https://ssrn.com/abstract=2826319 or http://dx.doi.org/10.2139/ssrn.2826319

Ying-Ju Chen

Hong Kong University of Science & Technology (HKUST) - Department of Information Systems, Business Statistics and Operations Management ( email )

Clear Water Bay
Kowloon
Hong Kong

Zhengqing Gui

National University of Singapore (NUS) - Risk Management Institute ( email )

21 Heng Mui Keng Terrace
Level 4
Singapore, 119613
Singapore

Ernst-Ludwig Von Thadden

Universitaet Mannheim ( email )

Department of Economics
Mannheim, 68131
Germany

Centre for Economic Policy Research (CEPR)

London
United Kingdom

European Corporate Governance Institute (ECGI)

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

Xiaojian Zhao (Contact Author)

Monash University - Department of Economics ( email )

Australia

HOME PAGE: http://https://sites.google.com/site/xjzhao81/

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