Composite contract design for enhancing emergency reserves

Abstract

To mitigate the impact of material shortages caused by emergencies, the government typically adopts an option contract to entrust enterprises with reserving materials in advance. During an emergency, the government purchases the materials wholesale and sells them to consumers. We integrate revenue-sharing and price-discount mechanisms into the option contract to explore effective ways to increase reserve quantity. We study three contracts: The option (OP) contract, a combination of the traditional option contract and a reward/punishment mechanism; the option and revenue-sharing (RS) contract, which allows the government to share part of the sales revenue with the enterprise based on the OP contract; and the option and price-discount (PD) contract, which involves the government selling materials at a discounted price based on the OP contract. First, we find that only when the government-required reserve quantity is relatively large can the government encourage an enterprise to reserve materials in advance through the OP, RS, and PD contracts. Moreover, only when the government-required reserve quantity is significantly larger dose the optimal reserve quantity under the RS or PD contracts exceed that under the OP contract. Second, compared to the OP contract, the government’s utility always decreases under the RS contract, while it can either increase or decrease under the PD contract. Both the RS and PD contracts have the potential to increase the enterprise’s utility, which depends on the government’s revenue-sharing and price-discount rates. Finally, we also consider other reserve modes: The government-enterprise joint reserve (GER) mode, which involves both the government and the enterprise reserving materials in advance; and the physical and production capacity reserve (PCR) mode, which combines the enterprise’s advance reservation with its immediate production after an emergency. We study the impact of the OP, RS, and PD contracts on the total reserve quantity in the GER and PCR modes and compare them with the base model, which only has enterprise reserves. The RS contract has the broadest applicability, followed by the OP and PD contracts.