Salesforce Contracting under Demand Censorship

We study salesforce contracting in an environment where excess demand results in lost sales and the demand information is censored by the inventory level. The firm in our model contracts a sales agent whose effort increases the demand stochastically. The sales agent that has limited wealth is protected to receive only nonnegative payment. The firm designs the incentive contract and invests in inventory, and the agent decides his selling effort after receiving the contract and observing the inventory level. We show that, without censoring of demand information, the first-best solution can always be achieved in our model; it is however untrue under demand censorship. We then prove based on the classic regularity condition that the threshold contract serves as the optimal contract format under demand censorship. We further analyze the contracting and inventory decisions for the additive and multiplicative effort cases. Our analysis reveals that, in the additive effort case, it could be optimal, under demand censorship, for the firm to induce an effort and maintain a service level both greater than the first-best solution; scenarios also exist where the firm shall induce zero effort. For the multiplicative effort case, the optimal selling effort under demand censorship is lower than the first-best effort while the optimal service level is higher than the first-best service level. The agent always earns zero rent in the additive effort case but may earn a positive rent in the multiplicative effort case. Our numerical study shows that the impact of demand censorship on the firm’s performance is the most significant when the sales margin is low and the market uncertainty is high