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Vertical Relations under Credit Constraints

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Listed author(s):
  • Nocke, Volker
  • Thanassoulis, John

Abstract

We model the impact credit constraints and market risk have on the vertical relationships between firms in the supply chain. Firms which might face credit constraints in future investments become endogenously risk averse when accumulating pledgable income. In the short run, the optimal supply contract therefore involves risk sharing, thereby inducing double marginalization. Credit constraints thus result in higher retail prices. The model offers a concise explanation for several empirical regularities of firm behavior. We demonstrate an intrinsic complementarity between supply and lending providing a theory of finance arms of major suppliers; a monetary transmission mechanism linking the cost of borrowing with short-run retail prices that can help explain the price puzzle in macroeconomics; a theory of countervailing power based on credit constraints; and a motive for outsourcing supply (or distribution) in the face of market risk.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 7636.

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Date of creation: Jan 2010
Handle: RePEc:cpr:ceprdp:7636
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Keywords: countervailing power; double marginalization; finance arms; financial companies; market risk; monetary transmission mechanism; outsourcing; price puzzle; risk aversion; risk sharing; vertical contracting;

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Find related papers by JEL classification:
  • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
  • L14 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Transactional Relationships; Contracts and Reputation
  • L16 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Industrial Organization and Macroeconomics; Macroeconomic Industrial Structure

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  1. Eugenio Gaiotti & Alessandro Secchi, 2004. "Is there a cost channel of monetary policy transmission? An investigation into the pricing behavior of 2,000 firms," Macroeconomics 0412010, EconWPA.
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Cited by:

  1. Léautier, Thomas-Olivier & Rochet, Jean-Charles, 2014. "On the strategic value of risk management," International Journal of Industrial Organization, Elsevier, vol. 37(C), pages 153-169.
  2. Mike Burkart & Tore Ellingsen, 2004. "In-Kind Finance: A Theory of Trade Credit," American Economic Review, American Economic Association, vol. 94(3), pages 569-590, June.
  3. Lømo, Teis Lunde, 2015. "Risk sharing mitigates opportunism in vertical contracting," Working Papers in Economics 10/15, University of Bergen, Department of Economics.
  4. John Thanassoulis, 2011. "The Case For Intervening In Bankers' Pay," Economics Series Working Papers 532, University of Oxford, Department of Economics.

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