Trade credit vs. supplier-guaranteed financing: Role of friction costs

The outbreak of COVID-19 has aggravated the financial constraints and credit default risks of firms. Two financing strategies initiated by the upstream suppliers are widely used to ease buyers' financial distress: trade credit (TC) and supplier-guaranteed financing (SG). We investigate these two financing strategies following the classic selling-to-the-newsvendor paradigm by further incorporating the buyer's financial constraint. We highlight the role of default and opportunity costs, which are significant financial frictions in practice. We obtain the equilibrium and find that the supplier should offer a risk-free interest rate under TC and provide a full guarantee under SG. Moreover, SG will always be used in equilibrium, while TC can be used only when the supplier's capital opportunity cost is relatively small. The rationale behind this difference is that the supplier incurs an opportunity cost due to the tied-up working capital with TC. Furthermore, owing to the joint effect of the two friction costs, there is a threshold level of the supplier's capital opportunity cost, below which the supplier offers TC and above which he offers SG. The buyer and the integrated supply chain also have a similar preference structure dependent on the supplier's capital opportunity cost. Finally, we extend the model by considering imperfect competition in the credit market and exogenous guarantee proportion. The significant insights still hold, and several interesting findings are revealed.