Trade Credit and Bankruptcy Risk in Supply Chains: An Experimental Study

Problem definition : In practice, supply chain parties often have limited capital, requiring them to seek financing and bear bankruptcy risk. In this paper, we behaviorally investigate a trade credit contract between a supplier and a capital-constrained retailer, the latter of which may face bankruptcy risk. After the supplier proposes a wholesale price, the retailer purchases a quantity through trade credit if its initial capital is insufficient and repays the supplier after demand is realized. If demand is too low, the retailer goes bankrupt. Methodology/Results : Through a controlled-laboratory experiment with human participants, we investigate how a retailer’s exposure to bankruptcy risk, which we vary through its initial capital, affects supply chain decisions and outcomes. We find that the presence of such bankruptcy risk leads to decisions that systematically differ when compared with a setting without bankruptcy risk. Among others, the retailer significantly understocks when exposed to bankruptcy risk, and the supplier attempts to offset this effect by offering a lower wholesale price. The resulting effect is that expected profits for the retailer, supplier, and supply chain are all significantly different than the baseline predictions. To account for these observed decisions, we show that a behavioral model of reference dependence and fairness organizes the data well. Managerial implications : Our work demonstrates that the presence of bankruptcy risk for a retailer significantly alters supply chain decisions in systematic ways, which has direct consequences on profits.