Limited Liquidity, Supplier Credits, and Timely Demand Information

Abstract

We consider supplier-credit contracting between a manufacturer and a liquidity-constrained dealer. We show that the timeliness according to which the dealer receives demand information has a significant impact on the optimal contract. If the manufacturer cannot be sure that a dealer without liquidity has demand information when the contract is written, the optimal contract pools an ignorant dealer with a dealer who knows that there are unfavorable demand conditions whereas dealers with favorable demand information are screened. If the dealer's liquidity rises, the manufacturer proposes a contract that resembles the solution of a classic adverse selection model in the spirit of Harris, Kriebel, and Raviv (1982). For high liquidity, the optimal supplier-credit contract pools an ignorant dealer with dealers who have favorable demand information whereas dealers with unfavorable demand information are screened.

Keywords: Supplier credit, supply chain contract, limited liquidity, ignorance

JEL Classification: D8, M1, M2