We consider how a firm dynamically allocates business among several suppliers to motivate them in a relational contract. The firm chooses one supplier who exerts private effort. Output is non-contractible, and each supplier observes only his own relationship with the principal. In this setting, allocation decisions constrain the transfers that can be promised to suppliers in equilibrium. Consequently, optimal allocation decisions condition on payoff-irrelevant past performance to make strong incentives credible. We construct a dynamic allocation rule that attains first-best whenever any allocation rule does. Thisallocation rule performs strictly better than any rule that depends only on payoff-relevant information. (JEL D21, D82, L14, L24).
ASJC Scopus subject areas
- Economics and Econometrics