Financing a capital-constrained supply chain: Equity or debt

Abstract

Many retailers are small and medium enterprises (SMEs) with limited access to capital to finance their operations. Here, we consider a supply chain consisting of a capital-constrained retailer and a manufacturer and examine the effect of equity and debt financing schemes on their operational decisions. Using a game theoretical approach, for the risk-neutral scenario, we take expected profit maximization as the participants’ objective to examine the equilibria of their operational and financing decisions. We also examine the condition under which the manufacturer and retailer adopt equity or debt financing to earn additional profits. We find that when the retailer is highly capital-constrained, she benefits from either financing scheme, but the manufacturer prefers to offer equity financing over debt financing. Otherwise, if the retailer is less constrained, debt financing is preferable. We also extend our analysis to risk-averse participants using the conditional value-at-risk (CVaR) criterion. We show that the decreasing monotone property of the order quantity in the wholesale price, known in the risk-neutral setting, no longer holds. Indeed, the relationship depends on the participants’ risk aversion level; if the manufacturer is highly risk-averse, it chooses to provide equity financing to enhance its CVaR performance; otherwise, it offers debt financing. Our findings provide implications for decision-makers in choosing the optimal financing options and making the associated operations and financing decisions when considering risk attitudes.