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MANAGEMENT SCIENCE Vol. 00, No. 0, Xxxxx 0000, pp. 000–000 issn 0025-1909 | eissn 1526-5501 | 00 | 0000 | 0001 INFORMS doi 10.1287/xxxx.0000.0000 c 0000 INFORMS Supply Chain Contract Design under Financial Constraints and Bankruptcy Costs Panos Kouvelis † , Wenhui Zhao ‡ † Olin Business School, Washington University, St. Louis, MO 63130, [email protected] ‡ Antai College of Economics and Management, Shanghai Jiao Tong University, Shanghai, China 200052, [email protected] We study contract design and coordination of a supply chain with one supplier and one retailer, both of which are capital constrained and in need of short-term financing for their operations. Competitively priced bank loans are available, and the failure of loan repayment leads to bankruptcy, where default costs may include variable (proportional to firm’s sales) and fixed costs. Without default costs, it is known that simple contracts (e.g., revenue-sharing, buyback and quantity discount) can coordinate and allocate profits arbi- trarily in the chain. With only variable default costs, buyback contracts remain coordinating and equivalent to rev enu e-sharing contracts, but are pare to dominated by rev enu e-sharing contract s when fixed default costs are present. Thus, for general bankruptcy costs, contracts without buyback terms are of most interest. Quantity discount contracts fail to coordinate the supply chain, since a necessary condition for coordination is to propor tiona lly reallocate debt oblig atio ns within the channel . With only var iable defaul t costs and with high fixed default costs exhibiting economies of scale, revenue-sharing contracts with working capital coordination continue to coordinate the chain. Unexpectedly, with fixed default costs and no economies of scale, the decentralized supply chain under a revenue-sharing contract with working capital coordination might have higher expected profit than the centralized chain. Our results provide support for the use of revenue-sharing contracts with working capital coordination for decentralized management of supply chains when there are bankruptcy risks and default costs. Key words : Newsvendor , Supply Contract, Supply Chain Coordination, Bankruptcy/Default Costs , and Working Capital Management. History : The paper wa s first submitted on June 26, 2010, and has b een with the authors for 31 mont hs for 3 revisions. 1. Introduction It is not uncommon in a supply chain that either the supplier and/or the retailer is the subsidiary of the other or they are both subsidiaries of the same parent company . For example, Target Brands 1

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