Equilibrium Financing in a Distribution Channel with Capital Constraint

Abstract

There exist capital constraints in many distribution channels. We examine a channel consisting of one manufacturer and one retailer, where the retailer is capital constrained. The retailer may fund its business by borrowing credit either from a competitive bank market or from the manufacturer, provided the latter is willing to lend. When only one credit type (either bank or trade credit) is viable, we show that trade credit financing generally charges a higher wholesale price and thus becomes less attractive than bank credit financing for the retailer. When both bank and trade credits are viable, the unique equilibrium is trade credit financing if production cost is relatively low but is bank credit financing otherwise. We also study the case where both the retailer and the manufacturer are capital constrained and demonstrate that, to improve the overall supply chain efficiency, the bank should finance the manufacturer if production cost is low but finance the retailer otherwise. Our analysis further suggests that the equilibrium region of trade credit financing shrinks as demand variability or the retailer's internal capital level increases.