Forced Labor in Labor Supply Chains - Contracting and Information Asymmetry

Problem definition: According to an estimate in 2022, labor-related human trafficking affects 23 million people globally. This form of exploitation is especially prevalent in 'labor supply chains' where buying companies rely on independent 'labor agents' to recruit and manage workers for them. We examine how the market and economic factors influence the occurrence of forced labor in these supply chains, and how buying companies can develop optimal contracts to prevent forced labor.Methodology/results: We develop a game-theoretic model of a labor supply chain with a buyer who cares about social responsibility and a profit-maximizing labor agent. The agent pays wages to workers and may use coercion to exploit them. We study the equilibrium contract price and audit level that the buyer can deploy to deter the agent from coercing workers. We show that the audit cost affects the extent to which the buyer can extract surplus from the agent. When the agent’s information is private, we design menus of contracts and show that the difference in the agent's earnings dictates how an unconstrained optimal contract has to be adjusted to be incentive compatible. When the buyer has to choose an agent from several candidates, we develop a 'sequential' menu of contracts that ensures no coercion and maximum buyer profit. We apply our model to a data set of labor agents for recruiting foreign agricultural workers in the US. By using our sequential optimal contract, we find that the buyer can capture 84% of the entire supply chain profit, while the agent only gets 3% and the workers 13%.Managerial implications: Coercion in the labor supply chain depends on how the firm sets its contract labor quantity, contract price, and audit level, especially when there is information asymmetry. To design contracts that align the incentives of the buyer and the agent to ensure coercion-free, the buyer has to leave some profit for the agent. This implies that the buyer needs to set its contract price higher than the fair wage for workers, which contrasts with traditional supply chain contracts