Trust and Trustworthiness in Imbalanced Markets

Abstract

In this thesis, we use the methodology of experimental economics to investigate issues of trust and trustworthiness in procurement and the supply chain.

First, we develop a procurement model in which both seller-side and buyer-side decisions are endogenous to the trading relationship. We investigate how a real-world contractual incentive mechanism, retainage, can be used to overcome the seller-side moral hazard problem. We find that retainage can improve trade efficiency but in-creases market prices and may deter participation. We offer managerial insights on how to design the retainage mechanism, conditional on levels of trust and trustworthiness.

Second, we extend the procurement model to incorporate a contingent contract and show analytically that this contract can mitigate the seller-side moral hazard problem. We observe in a lab experiment that suppliers strategically adjust their bids with a contingent contract and that the contingent contract has unintended behavioural con-sequences, with buyers rewarding sellers less for the quality of works delivered. The results have managerial implications for the use of hierarchical elements in contracts.

Third, we analyse theoretically and experimentally the horizontal effects of supply chain late payments. We show that if firms discount payment received after the standard term, then late payments feed into higher prices and reduced competition. Reneging on a standard payment term entails a penalty for the buyer set by a third-party. If this penalty is not set carefully, a welfare loss arises due to price externalities. We demonstrate how free-riding payment behaviours may emerge among financially weaker buyers in the firm population.