Vertical Relations Under Credit Constraints

Forthcoming, Journal of the European Economic Association.

WBS Finance Group Research Paper No. 188

31 Pages Posted: 18 Jul 2012

See all articles by Volker Nocke

Volker Nocke

University of Mannheim

John E. Thanassoulis

University of Warwick - Warwick Business School; UK Competition and Markets Authority; Oxford-Man Institute, University of Oxford

Multiple version iconThere are 2 versions of this paper

Date Written: July 9, 2012

Abstract

We model the impact credit constraints and market risk have on the vertical relationships between firms in the supply chain. Firms which might face credit constraints in future investments become endogenously risk averse when accumulating pledgable assets. In the short run, the optimal supply contract involves risk sharing, so inducing double marginalization. Credit constraints thus result in higher retail prices, and this is true whether the firm is debt or equity funded. Further, we offer a new theory of supplier finance arms as we show an intrinsic complementarity between supply and lending which reduces financing inefficiencies created by informational asymmetries. The model offers: a theory of countervailing power based on credit constraints; a transmission mechanism linking the cost of borrowing with retail prices; and a motive for outsourcing supply (or distribution) in the face of market risk.

Keywords: risk aversion, vertical contracting, double marginalization, outsourcing, risk sharing, countervailing incentives, finance arms, countervailing power

JEL Classification: L14, L16

Suggested Citation

Nocke, Volker and Thanassoulis, John E., Vertical Relations Under Credit Constraints (July 9, 2012). Forthcoming, Journal of the European Economic Association., WBS Finance Group Research Paper No. 188, Available at SSRN: https://ssrn.com/abstract=2111094

Volker Nocke

University of Mannheim ( email )

John E. Thanassoulis (Contact Author)

University of Warwick - Warwick Business School ( email )

Coventry CV4 7AL
United Kingdom

HOME PAGE: http://https://sites.google.com/site/thanassoulis/

UK Competition and Markets Authority ( email )

Victoria House
37 Southampton Row
London, WC1B 4AD
United Kingdom

Oxford-Man Institute, University of Oxford ( email )

Eagle House
Walton Well Road
Oxford, Oxfordshire OX2 6ED
United Kingdom

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