ABSTRACT

In channel negotiation between suppliers and retailers there is often significant uncertainty that is most often unevenly distributed between the two firms. While there is ample evidence in the literature that both risk aversion and fairness would matter in such context, there is a lack of evidence on how subjects' beliefs and preferences for risk and fairness interact, leaving open the question of what is the fair way of compensating risk aversion. To address the question, we model a pricing decision between a supplier and a retailer who may not be risk neutral and may care for fairness. We then compare the prediction of the theory model with data from two incentive compatible experiments. We find that subject's behavior is incompatible with preferences for risk and/or fairness in which subjects beliefs about the other players preferences are consistent with their actual preferences. Using a structural approach, we then estimate the behavioral parameters and find that suppliers underestimate the risk aversion of retailers leading to significant deadweight losses in situations where the retailer (vs. the supplier) carries the risk.