Impact of Loss-Aversion on a Financially-Constrained Supply Chain

Traditionally, in the area of production and operations management, the financial states and decision-makers’ behaviour regarding loss have been ignored in the supply chain, which may lead to infeasible or unrealistic practices or even catastrophic losses in practical supply chain operations. Therefore, this study aims to provide a model for operational efficiency in a financially constrained supply-chain system consisting of a financially deficient retailer, a supplier, and a bank, and to analyse the impact of the behaviour of the bank and the supplier on the operational decision. It is assumed that the bank provides a loan to the retailer considering the supplier’s credit guarantee for the retailer. The supplier’s credit guarantee implies that, if the retailer goes bankrupt after the sales season, then a pre-guaranteed proportion of the retailer’s loan is repaid by the supplier. Moreover, to capture the decision-makers’ behaviour regarding loss, it is assumed that the supplier and the bank are loss-averse in their risk preference on the final profit. Under this circumstance, it is intended to draw the theoretical implications by analysing a loss-averse behaviour model for a supplier and a bank, in which a kinked piecewise linear and concave utility function is considered. The optimal decision is analytically derived for the retailer (the optimal order quantity), the supplier (the optimal wholesale price), and the bank (the optimal interest rate). In addition, a sensitivity analysis is conducted to investigate how the model parameters affect the optimal decision for the retailer, the supplier, and the bank under different degrees of loss-aversion. The optimal decisions are shown to be highly affected by the degree of the loss-aversion coefficient of the bank and the supplier and to be more conservative than the result in the traditional case which optimises the risk-neutral expected profit (the unit degree of loss-aversion). The analytical results can be summarised as follows. First, as the wholesale price and the interest rate increase, the optimal order quantity decreases. Second, the more loss-averse the supplier is, the higher the optimal wholesale price that is offered to the retailer by the supplier. Third, the larger the credit guarantee that is provided to the retailer by the supplier, the higher the optimal wholesale price that is provided to the retailer. Fourth, the more loss-averse the bank is, the higher the interest rate that is offered to t