Loss-averse retailers’ financial offerings to capital-constrained suppliers: loan vs. investment

Abstract

Suppliers' insufficient capital can disrupt the normal operations of other participants in the supply chain. To alleviate suppliers' capital constraints, retailers have the option of providing financing. However, when addressing the risks of default, retailers should behave conservatively and sensitively, which results in loss-averse behaviors. Using a game theoretical approach, this study examines and compares two financing schemes available to loss-averse retailers: loan and investment. We find that both schemes bring additional value to the loss-averse retailer and the capital-constrained supplier, providing a win–win situation. An appropriate interest rate or proportional dividend is the prerequisite for both participants to adopt a loan or an investment scheme, respectively. For the loan scheme, the retailer's higher loss aversion causes him to reduce the wholesale price. In the investment scheme, a higher loss aversion reduces production quantity. We locate the Pareto improvement regions of the two schemes for both participants using comparative analysis. The retailer's higher loss aversion causes both participants to have lower chances of achieving Pareto improvements from supply chain financing. When the retailer is more loss averse and the supplier is highly capital constrained, both participants prefer an investment rather than the loan scheme. This study provides implications for participants adopting particular financing schemes to enhance profits and reduce risk.