Financing a Sustainable Supply Chain

38 Pages Posted: 3 Nov 2020

See all articles by Xiaole Chen

Xiaole Chen

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

Vernon Hsu

The Chinese University of Hong Kong

Guoming Lai

University of Texas at Austin - Red McCombs School of Business

Yang Li

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

Date Written: September 2, 2020

Abstract

Problem Definition: We study the effects of financing on supply chain sustainability.

Academic/Practical Relevance: In recent years, companies have increasingly used supply chain financing---as a replacement of bank financing---to engage their financially constrained suppliers. Our study is among the first in the supply chain literature to investigate the relative effectiveness of different financing mechanisms in support of supply chain sustainability.

Methodology: We consider a decentralized supply chain where a buyer sources from a financially constrained supplier. The supplier borrows from either a bank or the buyer to finance his production. The buyer audits the supplier for sustainability compliance and will accept and pay for the orders only if the supplier passes the audit.

Results: We find that under conventional bank financing, the bank that is concerned with the supplier's audit failure will raise the interest rate as the value of the supplier's collateral decreases. This not only hinders the supplier's compliance effort but also hurts the profitability of every stakeholder. In contrast, under buyer financing, the buyer may leverage financing to improve sustainability by offering the supplier a low interest rate. This occurs when the supplier's collateral is of low value. However, if the supplier's collateral is of high value, under buyer financing, the buyer may be tempted to set a high interest rate to exploit the supplier, which reduces both the supplier's compliance level and the supply chain profitability.

Managerial Implications: Our findings suggest that buyer financing may not always be an effective approach for encouraging supply chain sustainability. As such, we propose an alternative mechanism under which the buyer offers a reward to the supplier if he passes the audit while the supplier continues to borrow from a bank. We demonstrate that such a bank financing plus audit reward scheme both induces a higher sustainability compliance level and increases total supply chain profitability. Interestingly, it is more effective than buyer financing (even with similar audit reward) for sustainability especially when the supplier's collateral is of low value.

Keywords: supply chain finance, supply chain sustainability, responsible operations, environmental, social and corporate governance

Suggested Citation

Chen, Xiaole and Hsu, Vernon and Lai, Guoming and Li, Yang, Financing a Sustainable Supply Chain (September 2, 2020). Available at SSRN: https://ssrn.com/abstract=3685076 or http://dx.doi.org/10.2139/ssrn.3685076

Xiaole Chen

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

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

Vernon Hsu

The Chinese University of Hong Kong ( email )

Room 902
Cheng Yu Tung Building, No. 12 Chak Cheung Street
Hong Kong, 00000
China

Guoming Lai

University of Texas at Austin - Red McCombs School of Business ( email )

Austin, TX 78712
United States

Yang Li (Contact Author)

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

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

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