Trade credit, risk sharing, and inventory financing portfolios

Yang, S A and Birge, J R (2018) Trade credit, risk sharing, and inventory financing portfolios. Management Science, 64 (8). pp. 3469-3970. ISSN 0025-1909 OPEN ACCESS


As an integrated part of a supply contract, trade credit has intrinsic connections with supply chain coordination
and inventory management. Using a model that explicitly captures the interaction of firms' operations decisions, financial constraints, and multiple financing channels (bank loans and trade credit), this paper attempts to better understand the risk-sharing role of trade credit - that is, how trade credit enhances supply chain efficiency by allowing the retailer to partially share the demand risk with the supplier. Within this
role, in equilibrium, trade credit is an indispensable external source for inventory financing, even when the
supplier is at a disadvantageous position in managing default relative to a bank. Specifically, the equilibrium
trade credit contract is net terms when the retailer's financial status is relatively strong. Accordingly, trade
credit is the only external source that the retailer uses to finance inventory. By contrast, if the retailer's cash
level is low, the supplier offers two-part terms, inducing the retailer to finance inventory with a portfolio of trade credit and bank loans. Further, a deeper early-payment discount is offered when the supplier is relatively less efficient in recovering defaulted trade credit, or the retailer has stronger market power. Trade credit allows the supplier to take advantage of the retailer's financial weakness, yet it may also benefit both parties when the retailer's cash is reasonably high. Finally, using a sample of firm-level data on retailers, we empirically observe the inventory financing pattern that is consistent with what our model predicts.

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Item Type: Article
Subject Areas: Management Science and Operations
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© 2017 INFORMS

Date Deposited: 14 Mar 2017 10:03
Date of first compliant deposit: 13 Mar 2017
Subjects: S > Supply chain management
O > Operations planning and control
I > Inventory control
C > Capital theory
Last Modified: 20 Sep 2021 00:21

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