Trade Credit and Operational Investment: A Bargaining Perspective

Management Science and Operations

Social Sciences Research Network

Chu L Y; Yang S A; Yao J

S. Alex Yang

2024

This paper examines the role of trade credit in encouraging the downstream party in a supply chain to make demand-boosting operational investments (e.g., expanding the sales network, upgrading logistics and IT infrastructures) through the lens of bargaining. We consider a supply chain with one supplier and one retailer, neither financially constrained, interacting over multiple operating periods. In each period, the retailer makes a non-contractible investment to boost demand, followed by the two parties negotiating on contract terms via an alternating-offers bargaining process. We contrast two types of contracts: 1) cash-only benchmark (two parties bargain over delivery quantity and associated cash payment); 2) trade credit (in addition to quantity and cash payment, they bargain over trade credit payment, which the retailer pays to the supplier in the next period). Our analysis reveals that the cash-only benchmark leads to under-investment due to the classic holdup problem. Trade credit mitigates this holdup problem and encourages retailer investment by altering both the dynamics and termination conditions of the bargaining game. Consequently, it yields higher profits for both parties, resulting in a win-win situation. We further uncover how different factors affect the usage and benefit of trade credit in its bargaining role, such as more trade credit is used when the demand is more time-sensitive and interest rates are low; and trade credit is more valuable when investment returns are high. These insights are valuable for managers in structuring contracts and expand academic understanding of trade credit, bargaining, and mechanisms that alleviate potential holdup problems.

Bargaining; Investment; Trade credit; Holdup; Operations-finance interface

Social Sciences Research Network

No

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