AdONE Seminar: Prof. Christina Imdahl (Eindhoven University of Technology)

Normative (expected-profit-maximizing) theory assumes that decision-makers are fully rational, but in reality, they deviate from the optimal response. In contract negotiations, contract parameters are often optimized based on the assumption of rational behavior. Deviations from rational behavior can lead to significant costs for all parties involved. To address this, we propose robust optimization to obtain contract parameters that account for deviations from rational behavior. We apply this optimization approach to obtain the robustly optimal contract parameters for the buyback contract when there is limited knowledge of the buyers' responses. We develop a parameterization of the robust contract, called the naive robust contract, that is based on the pull-to-center effect.  We compare the naive robust contract to the normative, the naive robust and various behavioral contracts based on established behavioral response models in a lab experiment. The results show that a robust contract, built on simple assumptions, yields higher average supply chain profits than the normative contract. The robust contract also weakly dominates all other behavioral contracts, meaning that it significantly outperforms them in either average supply chain profit or risk. This approach offers a practical way to set contract parameters without relying on assumptions about the distribution of responses, except for the support.