Financing an overconfident distribution channel

Abstract

This paper examines the effect of overconfidence on financial decisions in a capital-constrained distribution channel where an upstream supplier with sufficient working capital produces goods for a downstream retailer who has limited working capital and may request trade credit from the upstream supplier. We obtain several interesting results. First, in a centralized financially constrained channel (CFCC) setting, we show that overconfidence has the results that both the optimal order quantity is tied to the mean of the uncertain market demand and that the supply chain is worse off. Second, in a decentralized financially constrained channel (DFCC) setting, the optimal order quantity with overconfidence is either higher or lower than that without overconfidence. When the retailer needs to ask for trade credit from the supplier, overconfidence means that the retailer’s order quantity is less affected by the wholesale price. We further numerically show that under market demand uncertainty, overconfidence may benefit a DFCC composed of an overconfident supplier and retailer. We also analyze the impacts of varying overconfidence levels on our results and find that the retailer may benefit when the retailer is more overconfident than the supplier.