How Cooperative Is ‘Cooperative Investment'?: Supply Chain Contracting in Presence of Epistemic Quality Uncertainty

The literature identifies the importance of cooperation in enhancing supply chain performance, but only a few papers have studied the role of cooperative investment in supply chain contracting. This article contributes to the literature of supply chain contracts by highlighting the importance of a cooperative investment in improving quality in presence of uncertainty. When the delivery of a high-quality product is uncertain and costly, the supplier may choose to deliver a less costly standard product, delivery of which is not uncertain, and hence the buyer needs to incentivize the supplier to take the risk. Using a principal-agent set-up, this article shows that incentivizing the supplier to choose the risky action of attempting delivery of the high-quality product is easier for the buyer in presence of shared cooperative investment that reduces epistemic quality uncertainty. However, the supplier passes the entire burden of investment on the buyer. The optimal investment for the buyer depends on parameters that determine effectiveness of the investment in reducing quality uncertainty.