Trade Credit in Supply Chains: Multiple Creditors and Priority Rules

Abstract

Priority rules determine the order of repayment when the debtor cannot repay all of his debt. In this paper, we study how different priority rules influence trade credit usage and supply chain efficiency when multiple creditors are present. We find that with only demand risk, when the wholesale price is exogenous, trade credit with high priority can lead to high chain efficiency, yet trade credit with low priority allows more retailers to obtain trade credit and suppliers to gain higher profits. When the supplier has control of the wholesale price, however, we show that the supplier should extend unlimited trade credit with net terms. We also study the case when demand risk mingles with other risks, especially those with longer terms. Under this setting, we show several scenarios when the optimal trade credit policy should change according to different risks and that, in general, trade credit with low priority results in high chain efficiency. Finally, we use empirical data to show that, at an aggregate level, trade credit usage reacts to changes in the law according to our theory.

Keywords: supply chain management, newsvendor model, trade credit, priority rules, bankruptcy, financial constraint