Incentives for Monitoring Quality

Abstract

We analyze a procurement problem in which the quality of the delivered product can be observed perfectly by the buyer and supplier, but may not be verifiable, i.e., may not be observable to any third party. We present a set of plausible conditions under which the equilibrium welfare of both the buyer and supplier is higher when quality is verifiable than when it is unverifiable. The welfare gain for the privately informed supplier arises even when the buyer has all the bargaining power. Thus, the interests of the buyer and supplier coincide with regard to whether delivered quality should be made verifiable.

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