Decision making in trade credit financing: impact of loss aversion and power imbalance

Abstract

AbstractWe incorporate loss aversion and power imbalance into a trade credit contract that sets both wholesale price and payment ratio at ordering time. Our models are based on a dyadic supply chain consisting of a loss‐averse supplier and a capital‐constrained retailer who can get finance via bank credit or trade credit. We derive the optimal trade credit contract under the retailer‐dominant noncooperative (RDN) and the supplier‐dominant noncooperative (SDN) games. Our results show that the impact of the supplier's loss aversion depends on whether the supplier dominates the supply chain. Specifically, under RDN scenario, a single bank credit should be adopted by the retailer, irrespective of the supplier's loss aversion. Under SDN scenario, however, a hybrid of bank credit and trade credit should be provided to the retailer when the supplier's loss aversion level exceeds a critical threshold value, and a single trade credit should be granted otherwise. Moreover, we find that the capital‐constrained retailer may benefit from the supplier's loss aversion behavior. Finally, we conduct a serial of numerical examples to develop more managerial insights.