Financing Supply Chain Resilience

We examine how financing arrangements and frictions affect supply chain resilience investments. In our game-theoretic model of a buyer, a supplier, and a bank, the supplier can invest in resilience, which reduces the supplier's production losses in case of a shock. The supplier is financially constrained and faces two financing frictions: moral hazard costs (the resilience investment is unobservable) and bankruptcy costs (future cash flows are lost in bankruptcy). We compare two financing arrangements: Under commercial loan financing, the supplier requests a loan from the bank; under buyer-intermediated financing (BIF), the supplier also obtains a loan from the bank, but the buyer guarantees the repayment and proposes the loan terms. Under commercial loan financing, we find that moral hazard costs can lead to credit rationing, limiting the supplier's resilience investments. In contrast, bankruptcy costs can accentuate these investments and change the direction of the moral hazard effect on investments. Bankruptcy costs can even motivate the supplier to invest more in resilience than she would without financing frictions. The buyer benefits from resilience and offers BIF only if it mitigates credit rationing. When BIF is offered, it always increases resilience. Surprisingly, financing frictions can increase the expected value for one of the firms: either the buyer or the supplier. The supplier's bankruptcy costs benefit the buyer when the supplier uses a commercial loan. Moral hazard costs can benefit the supplier when they motivate the buyer to offer BIF.