Abstract

http://ssrn.com/abstract=1734682
 
 

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How Inventory is (Should Be) Financed: Trade Credit in Supply Chains with Demand Uncertainty and Costs of Financial Distress


Song Alex Yang


London Business School

John R. Birge


University of Chicago - Booth School of Business

January 4, 2011


Abstract:     
As an integrated part of a supply contract, trade credit has intrinsic connections with supply chain contracting and inventory management. Using a model that explicitly captures the interaction of firms’ operations decisions and financial risks, this paper attempts to develop a deeper understanding of trade credit from an operational perspective. Revolving around the question of what role trade credit plays in channel coordination and inventory financing, we demonstrate that with demand uncertainty, trade credit enhances supply chain efficiency by serving as a risk-sharing mechanism. When offering trade credit, the supplier balances its impact on operational profit and costs of financial distress. Facing a trade credit contract, the retailer finances inventory using a portfolio of cash, trade credit, and short-term debt, where the structure of this inventory financing portfolio depends on the retailer’s financing need and bargaining power. Additionally, our model suggests that financial diversification, that is, employing multiple financing sources, provides an alternative explanation for the use of factoring in accounts receivable management and the decentralization of some supply chains. Finally, using a sample of firm-level data from Compustat, we find that the inventory financing pattern our model predicts exists in a wide range of firms.

Number of Pages in PDF File: 41

Keywords: trade credit, supply chain management, inventory management, newsvendor model, supplier financing, costs of financial distress, debt structure, financial constraint

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Date posted: January 5, 2011 ; Last revised: February 12, 2013

Suggested Citation

Yang, Song Alex and Birge, John R., How Inventory is (Should Be) Financed: Trade Credit in Supply Chains with Demand Uncertainty and Costs of Financial Distress (January 4, 2011). Available at SSRN: http://ssrn.com/abstract=1734682 or http://dx.doi.org/10.2139/ssrn.1734682

Contact Information

Song Alex Yang (Contact Author)
London Business School ( email )
Sussex Place
Regent's Park
London, London NW1 4SA
United Kingdom
John R. Birge
University of Chicago - Booth School of Business ( email )
5807 S. Woodlawn Avenue
Chicago, IL 60637
United States

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