Vertical Relational Contracts and Trade Credit

Marta Troya-Martinez

No 648, Economics Series Working Papers from University of Oxford, Department of Economics

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.

Keywords: Relational contracts; trade credit; imperfect monitoring (search for similar items in EconPapers)
JEL-codes: C73 D82 L14 (search for similar items in EconPapers)
Date: 2013-03-18
New Economics Papers: this item is included in nep-com and nep-cta
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

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