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Vertical Relational Contracts and Trade Credit

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  • Marta Troya-Martinez

Abstract

This paper uses a vertical relational contract between two firms to explore the implications of trade credit when the ability to repay is not observed by the supplier.� Trade credit limits the supplier's possibilities to punish the cashless downstream firms and termination may be used in equilibrium.� We find that the supplier always sells too little despite having enough instruments to fix the double marginalization problem.� The downward distortion in the quantity results from the need to make the contract self-enforced and/or to tackle the asymmetric information problem.� The distortion remains even as the firms become arbitrarily patient and a larger discount factor does not necessarily translate into a larger welfare.� We show that the optimal contract resembles a simple debt contract: if the fixed repayment is met, the contract continues to the next period.� Otherwise, the manufacturer asks for the highest possible repayment and terminates for a number of periods.� The toughness of the termination policy decreases with the repayment.

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Bibliographic Info

Paper provided by University of Oxford, Department of Economics in its series Economics Series Working Papers with number 648.

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Date of creation: 18 Mar 2013
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Handle: RePEc:oxf:wpaper:648

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Keywords: Relational contracts; trade credit; imperfect monitoring;

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