Dynamic Pricing Under Debt: Spiraling Distortions and Efficiency Losses

77 Pages Posted: 9 Jun 2016 Last revised: 24 May 2017

See all articles by Omar Besbes

Omar Besbes

Columbia Business School - Decision Risk and Operations

Dan Iancu

Stanford Graduate School of Business

Nikolaos Trichakis

Massachusetts Institute of Technology (MIT)

Date Written: February 26, 2017

Abstract

Firms often finance their inventory through debt and subsequently sell it to generate profits and service the debt. Pricing of products is consequently driven by both inventory and debt servicing considerations. We show that limited liability under debt induces sellers to charge higher prices and to discount products at a lower pace. We find that these distortions result in revenue losses that compound over time, leading to some form of performance spiral down. We quantify the extent to which these inefficiencies can be mitigated by practical debt contract terms that emerge as natural remedies from our analysis, and find debt amortization or financial covenants to be the most effective, followed by debt relief and early repayment options.

Keywords: dynamic pricing, debt, pricing distortions, channel efficiency, firm value, spiral-down

Suggested Citation

Besbes, Omar and Iancu, Dan and Trichakis, Nikolaos, Dynamic Pricing Under Debt: Spiraling Distortions and Efficiency Losses (February 26, 2017). Stanford University Graduate School of Business Research Paper No. 16-29, Columbia Business School Research Paper No. 16-46, Available at SSRN: https://ssrn.com/abstract=2791884

Omar Besbes

Columbia Business School - Decision Risk and Operations ( email )

New York, NY
United States

Dan Iancu (Contact Author)

Stanford Graduate School of Business ( email )

655 Knight Way
Stanford, CA 94305-5015
United States

Nikolaos Trichakis

Massachusetts Institute of Technology (MIT) ( email )

77 Massachusetts Avenue
50 Memorial Drive
Cambridge, MA 02139-4307
United States

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