Vertical relations under credit constraints

We model the impact credit constraints and market risk have on the vertical relation-ships between firms in the supply chain. Firms which might face credit constraints in future investments become endogenously risk averse when accumulating pledgeable as sets. In the short run, the optimal supply contract therefore involves risk sharing, so inducing double marginalization. Credit constraints thus result in higher retail prices. This is true whether the firm is debt or equity funded. Further, there is an intrinsic com-plementarity between supply and lending which reduces Önancing inefficiencies created by informational asymmetries. This provides a new theory of finance arms of major suppliers. Finally, the model offers a concise explanation for several empirical regularities of firm behavior: a theory of countervailing power based on credit constraints; a monetary transmission mechanism linking the cost of borrowing with short-run retail prices; and a motive for outsourcing supply (or distribution) in the face of market risk