Sourcing from Suppliers with Financial Constraints and Performance Risk

45 Pages Posted: 26 Oct 2015 Last revised: 22 Nov 2018

See all articles by Christopher S. Tang

Christopher S. Tang

University of California, Los Angeles (UCLA) - Anderson School of Management

S. Alex Yang

London Business School; The University of Hong Kong - Faculty of Business and Economics

Jing Wu

The Chinese University of Hong Kong (CUHK) - CUHK Business School

Date Written: January 15, 2017

Abstract

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.

Keywords: Operations-Finance interface, supply risk, purchase order finance, supply chain finance, supply chain management

Suggested Citation

Tang, Christopher S. and Yang, S. Alex and Wu, Jing, Sourcing from Suppliers with Financial Constraints and Performance Risk (January 15, 2017). Available at SSRN: https://ssrn.com/abstract=2679618 or http://dx.doi.org/10.2139/ssrn.2679618

Christopher S. Tang

University of California, Los Angeles (UCLA) - Anderson School of Management ( email )

110 Westwood Plaza
Los Angeles, CA 90095-1481
United States

S. Alex Yang (Contact Author)

London Business School ( email )

Sussex Place
Regent's Park
London, London NW1 4SA
United Kingdom

HOME PAGE: http://faculty.london.edu/sayang/

The University of Hong Kong - Faculty of Business and Economics ( email )

Pokfulam Road
Hong Kong
China

Jing Wu

The Chinese University of Hong Kong (CUHK) - CUHK Business School ( email )

Cheng Yu Tung Building
12 Chak Cheung Street
Shatin, N.T.
Hong Kong

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