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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.

Suggested Citation

  • Marta Troya-Martinez, 2013. "Vertical Relational Contracts and Trade Credit," Economics Series Working Papers 648, University of Oxford, Department of Economics.
  • Handle: RePEc:oxf:wpaper:648
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    File URL: http://www.economics.ox.ac.uk/materials/papers/12660/paper648.pdf
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    References listed on IDEAS

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    Cited by:

    1. Marta Troya-Martinez, 2017. "Self-Enforcing Trade Credit," Working Papers w0240, Center for Economic and Financial Research (CEFIR).
    2. repec:eee:indorg:v:52:y:2017:i:c:p:333-357 is not listed on IDEAS

    More about this item

    Keywords

    Relational contracts; trade credit; imperfect monitoring;

    JEL classification:

    • C73 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Stochastic and Dynamic Games; Evolutionary Games
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • L14 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Transactional Relationships; Contracts and Reputation

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