Trade credit contracting in a risk-averse supply chain under adverse selection and moral hazard

Abstract

Trade credit, as an effective tool for integrating and coordinating material, information, and financial flows in supply chain management, is becoming increasingly widespread. We explore how a manufacturer can design optimal trade credit contracts when a risk-averse retailer hides its sales cost information (adverse selection) and selling effort level (moral hazard). We develop incentive models for a risk-averse supply chain when adverse selection and moral hazard coexist, which are then compared with the results under single information asymmetry (moral hazard). Moreover, we analyze the effects of private information and risk-aversion coefficient on contract parameters, selling effort level and the profit or utility of the supply chain. The study shows that when the degree of retailer’s risk aversion is within a certain range, reasonable trade credit contracts designed by the manufacturer can effectively induce the retailer to report its real sales cost and encourage it to exert appropriate effort. Furthermore, we find that the optimal trade credit period, optimal transfer payment, and retailer’s optimal sales effort level under dual information asymmetry are less than under single information asymmetry. Numerical analysis are conducted to demonstrate the effects of the parameters on decisions and profits.