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Discussion Paper Details

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Title: Vertical Relations under Credit Constraints

Author(s): Volker Nocke and John Thanassoulis

Publication Date: January 2010

Keyword(s): countervailing power, double marginalization, finance arms, financial companies, market risk, monetary transmission mechanism, outsourcing, price puzzle, risk aversion, risk sharing and vertical contracting

Programme Area(s): Industrial Organization

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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Bibliographic Reference

Nocke, V and Thanassoulis, J. 2010. 'Vertical Relations under Credit Constraints'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=7636