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Contracting with Asymmetric Information in Supply Chains

When a retailer holds no private information, a powerful supplier can use several contract types to extract for herself the first-best channel profit, leaving the retailer nothing but his reservation profit. In the case where the retailer holds private information on the probability distribution of market demand, most well analyzed contracts do not allow the supplier to achieve for herself the first-best channel profit. In equilibrium, the retailer is able to extract an information rent above his reservation profit, and the overall channel may deviate from its first-best solution. Such a result seems to conform with the general notion that when two parties deal with each other, the less informed party cannot avoid paying an information rent to the informed party. This paper shows that using judicially designed wholesale price contracts involving a buyback policy, a supplier can theoretically avoid paying any information rent to the privately informed retailer, and, at the same time, can extract all the first-best channel profit.