The extant supply chain management literature has not addressed the issue of coordination in supply chains involving risk‐averse agents. We take up this issue and begin with defining a coordinating contract as one that results in a Pareto‐optimal solution acceptable to each agent. Our definition generalizes the standard one in the risk‐neutral case. We then develop coordinating contracts in three specific cases: (i) the supplier is risk neutral and the retailer maximizes his expected profit subject to a downside risk constraint; (ii) the supplier and the retailer each maximizes his own mean‐variance trade‐off; and (iii) the supplier and the retailer each maximizes his own expected utility. Moreover, in case (iii), we show that our contract yields the Nash Bargaining solution. In each case, we show how we can find the set of Pareto‐optimal solutions, and then design a contract to achieve the solutions. We also exhibit a case in which we obtain Pareto‐optimal sharing rules explicitly, and outline a procedure to obtain Pareto‐optimal solutions.

W e investigate how a supply chain involving a risk-neutral supplier and a downside-risk-averse retailer can be coordinated with a supply contract. We show that the standard buy-back or revenue-sharing contracts may not coordinate such a channel. Using a definition of coordination of supply chains proposed earlier by the authors, we design a risk-sharing contract that offers the desired downside protection to the retailer, provides respective reservation profits to the agents, and accomplishes channel coordination.

We analyze a supply chain consisting of a supplier and a retailer. The supplier's unit production cost, which characterizes his type, is only privately known to him. When trading with the retailer, the supplier demands a reservation profit that depends on his unit production cost. We model this problem as a game of adverse selection. In this model, the retailer offers a menu of contracts, each of which consists of two parameters: the ordering quantity and the supplier's share of the channel profit. We show that the optimal contract depends critically on a surrogate measure—the ratio of the types’ reservation profit differential to their production cost differential. An important implication from our analysis is that information asymmetry alone does not necessarily induce loss in channel efficiency. The optimal contract can coordinate the supply chain as long as the low‐cost supplier's cost efficiency is neither much overvalued nor much undervalued in the outside market. We further discuss the retailer's preference of the supplier's type under different market conditions, as well as evaluate the effects of the supplier's reservation profit, the retail price, and the demand uncertainty on the optimal contract.

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