Financing equilibrium in a capital constrained supply Chain: The impact of credit rating

Abstract

In this study, we investigate a supply chain comprising one well-funded supplier and one small-sized retailer with capital constraints. The supplier acts as a leader to distribute one newsvendor-type product via the retailer in the uncertain market demand. In the presence of capital shortages, the retailer has two different financing alternatives: bank financing and trade credit. Moreover, the small-sized retailer has an imperfect credit rating, which reflects the exogenous credit risk beyond the current supply chain transaction. By capturing both the demand risk and credit risk, we model each financing strategy and derive the optimal solutions. When both financing strategies are feasible, we prove that the retailer always benefits from bank financing, while the supplier’s preferences are determined by two critical factors (i.e., the retailer’s credit rating and the production cost). Considering that the supplier’s preferences are not always aligned with the retailer’s, we characterize a wholesale price Pareto zone, in which trade credit is the unique equilibrium. We further generalize our model to consider that the retailer with a positive initial budget, finding that the feasible regions of two financing formats shrink as the initial budget builds up. Interestingly, when the initial capital of the retailer is moderate (still capital shortages), we observe that trade credit is more likely to be the financing equilibrium if the retailer’s credit rating is low. These findings enrich our understanding of the impact of credit rating on financially constrained supply chain operational and financial decisions.