Information Disclosure Policy and Ratcheting in Supply Chains

Abstract

This paper studies implications of the ratcheting effect arising in the supply chain relationship. The ratcheting effect occurs when the retailer modifies his investment in the present period to receive a favorable wholesale price in the future. In a simple model of multi-period supply chain interactions, we demonstrate that such an endogenous ratcheting effect can have multi-faceted reverberations for the supply chain. We confirm the conventional wisdom that a retailer may take actions that harm the supply chain to stave off supplier opportunistic behavior. We consider two approaches to solve this ratcheting problem – market solution and regulatory solution. Under the market solution, we demonstrate that the traditional thinking is incomplete in that it fails to consider the supplier's endogenous response. Under the market solution, the supplier uses deep discounts of initial input prices to convince the retailer to focus on short-run profits rather than long-run concerns. These deep discounts not only encourage mutually beneficial investments but also alleviate double-marginalization inefficiencies along the supply chain. Moreover, we compare those results to the regulatory solution case where the retailer's private information is publicly observed through mandatory disclosure policy. We show that such mandatory disclosure would reduce the total channel efficiency compared to the market solution, where the manufacturer can strategically mitigate the ratcheting problem. Therefore, our model presents not only a scenario where ratcheting concerns are endogenous but also one where such ratcheting concerns result in socially beneficial responses. That is, it can be welfare-enhancing to permit firms to withhold forward-looking information.