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Efficient Sourcing and Debt Financing in Imperfect Product Markets

Author

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  • Venkat Subramaniam

    (A. B. Freeman School of Business, Tulane University, New Orleans, Louisiana 70118)

Abstract

Supplier relations play an important role in determining a firm's product market strategy and position, by affecting the cost and quality of the product produced by the firm. These relations are especially significant because the cost of purchased materials for an average firm is more than half its total sales. In this paper, we model the adverse incentives of a firm that sources from a competitive supplier industry. We show that a firm's propensity to behave opportunistically towards its suppliers raises the firm's input costs by decreasing the number of suppliers servicing it. This results in a suboptimal production decision compared to the firm's first best choice. We argue that an appropriate level of debt financing alters the shareholder incentives and mitigates the hold-up problem. Further, we also show that at the optimal debt level, the firm produces its first best level of output.

Suggested Citation

  • Venkat Subramaniam, 1998. "Efficient Sourcing and Debt Financing in Imperfect Product Markets," Management Science, INFORMS, vol. 44(9), pages 1167-1178, September.
  • Handle: RePEc:inm:ormnsc:v:44:y:1998:i:9:p:1167-1178
    DOI: 10.1287/mnsc.44.9.1167
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    File URL: http://dx.doi.org/10.1287/mnsc.44.9.1167
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    References listed on IDEAS

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    Cited by:

    1. Claudio Piga, 2002. "Debt and Firms' Relationships: The Italian Evidence," Review of Industrial Organization, Springer;The Industrial Organization Society, vol. 20(3), pages 267-282, May.
    2. Serel, Dogan A. & Dada, Maqbool & Moskowitz, Herbert, 2001. "Sourcing decisions with capacity reservation contracts," European Journal of Operational Research, Elsevier, vol. 131(3), pages 635-648, June.
    3. Bin Jiang, 2009. "Implementing Supplier Codes of Conduct in Global Supply Chains: Process Explanations from Theoretic and Empirical Perspectives," Journal of Business Ethics, Springer, vol. 85(1), pages 77-92, March.
    4. T. Franck & N. Huyghebaert, 2004. "On the Interactions between Capital Structure and Product Markets.A Survey of the Literature," Review of Business and Economic Literature, KU Leuven, Faculty of Economics and Business (FEB), Review of Business and Economic Literature, vol. 0(4), pages 727-787.
    5. Fraja, Gianni De & Piga, Claudio A. G., 2004. "Strategic debt in vertical relationships: theory and evidence," Research in Economics, Elsevier, vol. 58(2), pages 103-123, June.
    6. Brett W. Myers & Alessio Saretto, 2016. "Does Capital Structure Affect the Behavior of Nonfinancial Stakeholders? An Empirical Investigation into Leverage and Union Strikes," Management Science, INFORMS, vol. 62(11), pages 3235-3253, November.

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