Risk propagation through payment distortion in supply chains

• Date: 01 March 2018
• Author: Rogelio Oliva,Alejandro Serrano,Santiago Kraiselburd
• DOI: http://doi.org/10.1016/j.jom.2018.01.003
• Published date: 01 March 2018

Contents lists available at ScienceDirect

Journal of Operations Management

journal homepage: www.elsevier.com/locate/jom

Risk propagation through payment distortion in supply chains

Alejandro Serrano

a,b

, Rogelio Oliva

c,∗

, Santiago Kraiselburd

d,e

a

IESE Business School, Avenida Pearson 21, 08034, Barcelona, Spain

b

MIT-Zaragoza International Logistics Program, Zaragoza Logistics Center, C/ Bari 55, Edificio Nayade 5 (PLAZA), 50197, Zaragoza, Spain

c

Mays Business School, Texas A&M University, TAMU 4217, College Station, TX, 77843, USA

d

Escuela de Negocios, Universidad Torcuato Di Tella, Alte. Saenz Valiente 1010, C1428BIJ, Buenos Aires, Argentina

e

INCAE Business School, Campus Walter Kissling Gam, La Garita, Alajuela, 960-4050, Costa Rica

ARTICLE INFO

Accepted by: Professor Suzanne de Treville.

Keywords:

Supply chain management

Risk

Bullwhip effect

Credit contagion

Empirical modelling

Operations management-finance link

ABSTRACT

The supply chain literature has devoted much attention to studying how the variability of orders propagates

upstream. We explore how this insight extends to the variability of payments to suppliers and its impact on how

risk is generated and propagates upstream. To do so, we model the financial features of a supply chain based on

industry reports and empirical findings from the finance literature. Capturing policies and constraints of the

agents in the supply chain in a formal model, we are able to generate and explain the behavior observed in real

supply chains. We show that payment variability occurs and propagates, even if orders are constant, in a cash-

constrained supply chain. Furthermore, our model reveals that payment variability may even become amplified

under severe cash restrictions. We identify the factors that drive the propagation of variability—the industry

risk, the firm's operational leverage, the existence of a financial leverage target, and the cost of debt. The model

also makes it possible to explore states of nature not often observed in practice, but that may have an effect in

managers' behavior, for example, bankruptcies. We numerically illustrate the impact of these drivers on the risk

of upper echelons (suppliers and suppliers' suppliers) as well as the interactions between order and payment

variability. We close by summarizing our findings and discussing future research opportunities.

1. Introduction

Supply Chain Management (SCM) is concerned with three flow-

s—products, information, and money. To date, SCM literature has ex-

plored the benefits of integrated information flows in the supply chain

(e.g., Pagell, 2004; Chen, 2003) as well as the competitive advantages

of having a fully integrated product stream from supplier to consumer

(Frohlich and Westbrook, 2001). This literature, however, has been

almost silent on the effects of integration on the financial flows between

members of the supply chain and their impact on the state variables

that limit these flows. Although material and financial flows are in-

timately related, cash flows often deviate from order flows and payment

variability may occur even in the absence of order variability. In this

paper, we explore the impact of financial flows on operational perfor-

mance. We believe a more careful look into financial flows is necessary

as firms are becoming more leveraged,

1

and given the clear patterns of

risk propagation and bankruptcies along established supply chains (e.g.,

Allen and Gale, 2000; Demange, 2016; Egloffet al., 2007). While

bankruptcy itself is a rare event, financial distress does affect the risk

perception and decision making of agents in a supply chain.

The “financial contagion”identified by the finance literature refers

to the increased likelihood of a firm defaulting to its suppliers as a result

of its customers' defaults on trade credit, such as customers paying later

than agreed (Boissay and Gropp, 2013). The existence of financial

contagion via trade credit defaults suggests not only that payments to

suppliers are subject to variability, but also that that variability is

somehow transmitted upstream. As payment variability represents one

type of supply-chain risk, financial contagion is able to spread from a

single dyad to an industry, potentially even affecting an entire economy

(Bardos and Stili, 2007; Goldin and Mariathasan, 2014). The crisis of

2008 is a good example of widespread contagion because of “massive

illiquidity”(Tirole, 2011). Right after the Lehman Brothers episode in

September 2008, the credit crisis worsened among financial institutions

precisely because of the fear of financial contagion (Jorion and Zhang,

2009).

Two trends make financial contagion through trade credit particu-

larly relevant. First, firms are relying more heavily on trade credit (see

Choi and Kim, 2005). During 2001 in France, accounts payable stood at

https://doi.org/10.1016/j.jom.2018.01.003

Received 18 October 2016; Received in revised form 29 December 2017; Accepted 22 January 2018

∗

Corresponding author.

E-mail address: roliva@tamu.edu (R. Oliva).

1

For instance, retailers' financial leverage, as measured by total assets over total equity, has increased by roughly 12% in the last 10 years in the US. Source: COMPUSTAT, US retailers

(SIC codes available on request) 2005–2014.

Journal of Operations Management 58–59 (2018) 1–14

Available online 01 May 2018

0272-6963/ © 2018 Elsevier B.V. All rights reserved.

T