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Dynamic Pricing Under Debt: Spiraling Distortions and Efficiency Losses

Author

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  • Omar Besbes

    (Graduate School of Business, Columbia University, New York, New York 10027)

  • Dan A. Iancu

    (Graduate School of Business, Stanford University, Stanford, California 94305)

  • Nikolaos Trichakis

    (MIT Sloan School of Management, Massachusetts Institute of Technology, Cambridge, Massachusetts 02142)

Abstract

Firms often finance their inventory through debt and subsequently sell it to generate profits and service the debt. Pricing of products is consequently driven by inventory and debt servicing considerations. We show that limited liability under debt induces sellers to charge higher prices and to discount products at a slower pace. We find that these distortions result in revenue losses that compound over time, leading to some form of performance spiral down. We quantify the extent to which these inefficiencies can be mitigated by practical debt contract terms that emerge as natural remedies from our analysis, and find debt amortization or financial covenants to be the most effective, followed by debt relief and early repayment options.

Suggested Citation

  • Omar Besbes & Dan A. Iancu & Nikolaos Trichakis, 2018. "Dynamic Pricing Under Debt: Spiraling Distortions and Efficiency Losses," Management Science, INFORMS, vol. 64(10), pages 4572-4589, October.
    • Handle: RePEc:inm:ormnsc:v:64:y:2018:i:10:p:4572-4589
    DOI: 10.287/mnsc.2017.2862
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