Downstream Firm's Equity Financing for Capacity Expansion in a Supply Chain

40 Pages Posted: 7 Sep 2021

See all articles by Hong Fu

Hong Fu

The School of Management, Hefei University of Technology

Shuo Xu

The School of Management, Hefei University of Technology

Lei Guan

affiliation not provided to SSRN

Lianmin Zhang

Shenzhen Research Institute of Big Data; Nanjing University

Date Written: September 3, 2021

Abstract

In this research, we investigate a supply chain consisting of a downstream firm who purchases
a component from an upstream firm, and then transforms it into a final product. The downstream
firm has a production capacity constraint and considers to raise capital from an investor through
equity financing. The raised capital not only enables the downstream firm to expand the capacity,
but also allows the investor to hold equity shares in the downstream firm. In detail, we consider
two equity financing models: in the external equity financing model, the capital is raised from
an outside institution; while in the internal equity financing model, the capital is raised from
the upstream firm. We derive the optimal pricing decisions of the two firms, and discuss the
optimal equity financing strategy. Because the cooperative relationship between the two firms
can be improved in the internal equity financing model, the production quantity in this model
may be even higher than that in a benchmark model with no capacity constraint and no equity
shares held by the investor in the downstream firm. Moreover, although the original shareholder
of the downstream firm always has a chance to benefit from the two types of equity financing, it
is more advantageous to raise capital from the upstream firm. We also analyze the impacts of the
key parameters on the financing strategy, and find that the dependence of the financing strategy
on the initial asset of the downstream firm in the two models are quite different. Numerical
studies show that less capital raised for expanding capacity may create more value for the original
shareholder of the downstream firm when the production cost of the downstream firm is changed.

Keywords: Supply chain; Equity financing; Capacity expansion; Equity holding

Suggested Citation

Fu, Hong and Xu, Shuo and Guan, Lei and Zhang, Lianmin, Downstream Firm's Equity Financing for Capacity Expansion in a Supply Chain (September 3, 2021). Available at SSRN: https://ssrn.com/abstract=3916762

Hong Fu (Contact Author)

The School of Management, Hefei University of Technology ( email )

193 Tunxi Road
Hefei, Anhui 230009
China

Shuo Xu

The School of Management, Hefei University of Technology ( email )

193 Tunxi Road
Hefei, Anhui 230009
China

Lei Guan

affiliation not provided to SSRN

Lianmin Zhang

Shenzhen Research Institute of Big Data ( email )

Nanjing University ( email )

Nanjing, Jiangsu 210093
China

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