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.

Two innovative financing schemes have emerged in recent years to enable suppliers to obtain financing for production. The first, purchase order financing (POF), allows financial institutions to offer loans to suppliers by considering the value of purchase orders issued by reputable buyers. Under the second, which we call buyer direct financing (BDF), manufacturers issue both sourcing contracts and loans directly to suppliers. Both schemes are closely related to the supplier's performance risk (whether the supplier can deliver the order successfully), which the repayment of these loans hinges upon. To understand the relative efficiency of the two emerging schemes, we analyze a game-theoretical model that captures the interactions between three parties (a manufacturer, a financially constrained supplier who can exert unobservable effort to improve delivery reliability, and a bank). We find that when the manufacturer and the bank have symmetric information, POF and BDF yield the same payoffs for all parties irrespective of the manufacturer's control advantage under BDF. The manufacturer, however, has more flexibility under BDF in selecting contract terms. In addition, even when the manufacturer has superior information about the supplier's operational capability, the manufacturer can efficiently signal her private information via the sourcing contract if the supplier's asset level is not too low. As such, POF remains an attractive financing option. However, if the supplier is severely financially constrained, the manufacturer's information advantage makes BDF the preferred financing scheme when contracting with an efficient supplier. In particular, the relative benefit of BDF (over POF) is more pronounced when the supply market contains a larger proportion of inefficient suppliers, when differences in efficiency between suppliers are greater, or when the manufacturer's alternative sourcing option is more expensive.

T his paper examines how a firm's financial distress and the legal environment regarding the ease of bankruptcy reorganization can alter product market competition and supplier-buyer relationships. We identify three effects-predation, bail-out, and abetment-that can change firms' behavior from their actions in the absence of financial distress. The predation effect increases competition before potential bankruptcy as the nondistressed competitor behaves as if it has some first-mover advantage that could benefit a supplier with price control. The bail-out effect reflects the supplier's incentive to grant the distressed firm concessions to preserve competition, improving supply chain efficiency and providing support for the exclusivity rule in Chapter 11 of the United States Bankruptcy Code when the supplier and the distressed firm are financially linked. The abetment effect is that the supplier may deliberately abet the competitor's predation, leading to increased operational disadvantages for the distressed firm before bankruptcy. Together these effects stress that a firm's bankruptcy potential can hurt its competitors and benefit its suppliers/customers. They also provide guidelines for firms' operational decisions in such situations, a rationale for observed firm actions surrounding bankruptcies, and motivation for policies supporting reorganization and relaxing broad enforcement of nondiscriminatory pricing regulations.

Trade credit is a widely adopted industry practice. Prior research has focused on how trade credit benefits firms by improving vertical supply chain relationships. This paper offers a novel perspective by examining whether trade credit can benefit suppliers through a horizontal channel. Under the classic Bertrand competition framework, we analyze two competing firms’ price decisions with and without trade credit. We find that when the firms are financially constrained, trade credit softens horizontal price competition. Specifi- cally, with trade credit, the firms will behave less aggressively in setting their prices for fear of incurring additional financing costs, resulting in equilibrium prices above the marginal cost, even if the products are perfect substitutes. Equilibrium profits under trade credit may thus be strictly higher than those under cash contracts. Furthermore, we find that with trade credit, a financially stronger firm may be able to exclude its weaker competitor from the market. We also investigate the relationship between the firms’ financial strength and their physical capacity in the competition with trade credit. We find that the horizontal benefit of trade credit over cash contracts increases as either the firms’ physical capacities increase or their financial status weakens. Therefore, with trade credit, firms’ financial constraints are a partial substitute for the role that physical capacity plays in price competition. Finally, we study the firms’ choice between offering trade credit and cash contracts. We find that trade credit is the equilibrium contract form if customers value trade credit, suggesting that the horizontal benefit of trade credit may complement its vertical roles

Trade credit insurance (TCI) is a risk management tool commonly used by suppliers to guarantee against payment default by credit buyers. TCI contracts can be either cancelable (the insurer has the discretion to cancel this guarantee during the insured period) or noncancelable (the terms cannot be renegotiated within the insured period). This paper identifies two roles of TCI: the (cash flow) smoothing role (smoothing the supplier’s cash flows) and the monitoring role (tracking the buyer’s continued creditworthiness after contracting, which enables the supplier to make efficient operational decisions regarding whether to ship goods to the credit buyer). We further explore which contracts better facilitate these two roles of TCI by modeling the strategic interaction between the insurer and the supplier. Noncancelable contracts rely on the deductible to implement both roles, which may result in a conflict: a high deductible inhibits the smoothing role, whereas a low deductible weakens the monitoring role. Under cancelable contracts, the insurer’s cancelation action ensures that the information acquired is reflected in the supplier’s shipping decision. Thus, the insurer has adequate incentives to perform its monitoring function without resorting to a high deductible. Despite this advantage, we find that the insurer may exercise the cancelation option too aggressively; this thereby restores a preference for noncancelable contracts, especially when the supplier’s outside option is unattractive and the insurer’s monitoring cost is low. Noncancelable contracts are also relatively more attractive when the acquired information is verifiable than when it is unverifiable. This paper was accepted by Vishal Gaur, operations management.