Contract design and the control of quality in a conflictual environment

This paper provides an approach to quality supply by a supplier and quality inspection by a producer, which explicitly recognizes the inherently opposing interests these two parties may have. The supplier and the producer are modeled as players in a nonzero sum game, where the supplier can control the effort invested in the delivery of quality and the producer may or may not inspect incoming materials. We study the effect of contract design (e.g. stipulation of penalties for defective units) on equilibrium behavior and identify conditions on the contract parameters which will result in the implementation of a cooperative solution.