Economics of Multitier Supply Chain Financing

Problem definition : Supply chain financing solutions allow financially weaker suppliers to secure funding based on the stronger financial standing of their buyers, presenting an alternative to conventional financing. This paper explores the preferences between immediate-tier financing (involving a direct buyer of the supplier) and remote-tier financing (involving a buyer’s buyer). Methodology/results : Using a model of a three-tier supply chain and a financial market, we solve for the subgame-perfect Nash equilibrium for a game comprising supply chain financing supergame and financing subgames between a firm and investors, subject to equilibrium pricing of firms’ assets-in-place and moral hazard frictions. The game is dynamic and stochastic because production shocks and financing subgames occur over time, coinciding with trade transactions between firms, and because of the stochastic evolution of information about firms’ assets-in-place affecting demand for products of each firm. We identify three economic mechanisms that stem from the relative position of firms in the supply chain and that work against remote-tier financing: risk spillover, noise accumulation, and loss of hedging options. Risk spillover occurs when a firm’s pledge of assets to secure supplier financing increases its own financing risk, affecting upstream firms and transactions. Noise accumulation refers to the greater uncertainty in forecasts of asset values, which are realized later for remote-tier buyers. The loss of the hedging option occurs because, by helping the supplier initially, the remote-tier buyer loses some of the capacity to help the immediate-tier buyer later. These mechanisms may explain challenges faced by remote-tier supply chain financing in practice. Managerial implications : The paper highlights the challenges faced by remote-tier financing and identifies conditions under which it can be favorable. It extends traditional finance models to incorporate supply chain considerations, demonstrating the importance of these factors in economic and financial decision making.