Working Paper: CEPR ID: DP7636
Authors: Volker Nocke; John Thanassoulis
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.
Keywords: Countervailing power; Double marginalization; Finance arms; Financial companies; Market risk; Monetary transmission mechanism; Outsourcing; Price puzzle; Risk aversion; Risk sharing; Vertical contracting
JEL Codes: G32; L14; L16
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Credit constraints (E51) | endogenous risk aversion in firms (D22) |
| endogenous risk aversion in firms (D22) | investment decisions (G11) |
| endogenous risk aversion in firms (D22) | retail pricing (D49) |
| Credit constraints (E51) | investment decisions (G11) |
| Credit constraints (E51) | retail pricing (D49) |
| Higher interest rates (E43) | increased risk aversion in firms (G32) |
| increased risk aversion in firms (G32) | retail prices (D49) |
| Bargaining power (C79) | retail prices (D49) |
| Bargaining power (C79) | investment levels (F21) |