Contract design of quality control in supply chain based on hidden action

The problem how to design a quality control contract in supply chain theory is discussed on a basis of principal-agent. A system consisting of a risk neural supplier and a risk neural seller is considered, in which the seller buys an intermediate good from the supplier. When both the supplier´s quality prevention costs and the seller´s quality appraisal costs can´t be observed by the other party, the problem of double hidden action will occur. General and concrete quality control models are established. In these models, two incentive measurements are taken: one is the penalty paid by the supplier to the seller when the seller identify a defective product, and the other is the penalty paid by the supplier to the seller when the defective product is found after being sold to customer. The results show that the appropriate penalty to the party with hidden action can reduce the influence of double hidden action and improve the quality of products sold to customers in designing contract of quality control.