Procurement with asymmetric information about fixed and variable costs

Abstract

We investigate optimal rationing of resources and organizational slack when a principal procures from an agent with private information about fixed and variable costs. We study the problem in a two-period setting with persistent types and investigate how the optimal rationing and slack depend on whether production increases or decreases over time. We find that rationing in a dynamic model with persistent types is extra costly, since the types that are eliminated in Period 1 might have been attractive in Period 2. The cost of rationing increases with the variability of production. If production levels are increasing (decreasing), the principal will be cautious when eliminating types with low variable (fixed) costs in Period 1, since these types are particularly profitable in Period 2. When production is more stable over time, harsher rationing can be applied in Period 1, followed by less-harsh rationing, if any, in Period 2.